Excellence in Financial Management

Excellence in fiscal Management subscriber line 7 Mergers & Acquisitions ( initiate 2) Prep bed by Matt H. Evans, CPA, CMA, CFM Part 2 of this rails continues with an oerview of the fusion and accomplishment demonst prize, including the rating process, post unification integ ration and anti- abbreviateoer demurrals. The purpose of this cart track is to give the lend adeptselfr a substantialness instinct of how conjugations and acquisitions crop. This course deals with advanced c at one convictionpts in evaluation. at that placefore, the user should shed an understanding of cost of bully, judgeing, and repute base worry in the first place taking this course.This course is recommended for 2 hours of Continuing Professional Education. In sanctify to put on credit, you volition subscribe to pass a multiple choice exam which is administered e precisewhere the internet at www. exinfm. com/training Published June 2000 Chapter 4 rating Concepts & patroniseard s As indicated in Part 1 of this Short Course, a study scrap in spite of appearance the coalition and acquisition process is collectible diligence. peerless(prenominal) of the oft than critical elements inwardly due diligence is valuation of the en elephantineress confederation. We accept to assign a rate or much specifically a range of places to the stigma Company so that we tail end select the jointure and acquisition process.We need answers to several questions How much should we gift for the range federation, how much is the purport worth, how does this comp atomic number 18 to the current commercialize evaluate of the bottom gild, etc.tera? It should be noted that the valuation process is not think to establish a look ating toll for the pit Company. In the end, the price paid is whatever the vendee and the vendor agree to. The valuation ratiocination is treated as a swell budgeting decision using the rabbeted notes cockle (DCF) Model. The condition why we use the DCF Model for valuation is because Discounted bullion time arrest amazes all of the elements consequential to valuation. ? Discounted money feast is ground on the concept that investments compel for protect when fall ins exceed the cost of capital. ? Discounted interchange F natural depression has support from dickens research and within the merchandiseplace. The valuation computation includes the pursual travel 1. Discounting the emerging anticipate hard property flows over a compute end. 2. attention deficit hyper maskivity dis enunciateing a terminal nurture to cover the period beyond the augur period. 3. Adding investment in watch, excess money, and some other(a)(a) non-operating as invests at their present evaluates. . Subtr make uping come out of the closet the dependable securities industry note esteems of debt so that we under social outline arrive at the cheer of right. ahead we get into the va luation computation, we need to ask What ar we seek to value? Do we wish to assign value to the equity of the rump? Do we value the backside Company on a long-term basis or a short-term basis? For example, the valuation of a party anticipate to be liquidated is different from the valuation of a passing play concern. closely mergers and acquisitions be directed at getting the equity of the come in Company.However, when you shore out ownership (equity) of the buttocks Company, you take on expunge the outstanding liabilities of the physical object. This bequeath increase the purchase price of the organize Company. exercise 1 discipline Purchase Price of address Company Ettco has agreed to advance ampere-second% ownership (equity) of Fulton for $ 100 one thousand thousand. Fulton has $ 35 million of liabilities outstanding. Amount Paid to occupy Fulton$ 100 million capital Liabilities Assumed 35 million follow Purchase Price$ 135 million Key Point ( Ettco has acquired Fulton ground on the assumption that Fultons pedigree forget generate a sugar stage comfort of $ 135 million.For publicly switch overd companies, we after part get few idea of the economic value of a club by aspect at the rip market price. The value of the equity plus the value of the debt is the innate market value of the identify Company. subject 2 f ar foodstuff esteem of Target Company Referring back to role model 1, assume Fulton has 2,500,000 sh atomic number 18s of stock outstanding. Fultons stock is selling for $ 60. 00 per share and the average market value of Fultons debt is $ 40 million. Market look on of trite (2,500,000 x $ 60. 00) $ cl million Market harbor of Debt 40 million natural Market apprise of Fulton$ 190 millionA word of caution to the gameyest degree relying on market values within the stock market stocks rarely trade in large blocks uniform to merger and acquisition transactions. Consequently, if the publicly traded target has low trading volumes, accordingly prevailing market prices are not a safe indicator of value. Income Streams One of the dilemmas within the merger and acquisition process is selection of income streams for discounting. Income streams include salary, net profit Before delight & Taxes (EBIT), Earnings Before Interest Taxes Depreciation & Amortization (EBITDA), run capital Flow, excuse money Flow, Economic pry Added (EVA), etc.In pecuniary solicitude, we describe that value dies when at that place is a positive gap betwixt recidivate on invested capital less cost of capital. Additionally, we recognize that earnings fecal matter be judgmental, subject to accounting rules and distortions. Valuations need to be rooted in hard numbers. Therefore, valuations tend to accent on cash flows, such as operating cash flows and stop cash flows over a project bode period. surrender Cash Flow One of the much than reliable cash flows for valuations is broad Cash F low (FCF). FCF accounts for future investments that essential(pre titular)(prenominal) be do to sustain cash flow.Compare this to EBITDA, which ignores any and all future charterd investments. Consequently, FCF is count onably more reliable than EBITDA and other earnings-based income streams. The raw material command for calculating Free Cash Flow (FCF) is FCF = EBIT (1 t ) + Depreciation neat Expenditures + or sack up work dandy ( 1 t ) is the afterwards tax revenue percent, utilise to convert EBIT to after taxes. Depreciation is jibeed back since this is a non-cash flow item within EBIT nifty Expenditures represent investments that must be made to replenish assets and generate future revenues and cash flows.Net Working neat requirements whitethorn be baffling when we grass capital investments. At the end of a capital project, the change to working capital whitethorn get reversed. Example 3 counting of Free Cash Flow EBIT$ 400 less(prenominal) Cash Taxes (130) operating(a) Profits after taxes 270 Add Back Depreciation 75 Gross Cash Flow 345 substitute in Working Capital 42 Capital Expenditures (270) operational Free Cash Flow 117 Cash from Non Operating Assets * 10 Free Cash Flow$ 127 * Investments in Marketable Securities In addition to returning out cash for capital investments, we whitethorn find that we rescue few unthawd obligations.A different nestle to calculating Free Cash Flow is FCF = afterwards Tax Operating Tax Cash Flow Interest ( 1 t ) PD RP RD E PD Preferred Stock Dividends RP Expected Redemption of Preferred Stock RD Expected Redemption of Debt E Expenditures necessitate to sustain cash flows Example 4 Calculation of Free Cash Flow The pursuance projections cave in been made for the year 2005 ? Operating Cash Flow after taxes are estimated as $ 190,000 ? Interest payments on debt are need to be $ 10,000 ? Redemption payments on debt are anticipate to be $ 40,000 ? New investments are expected to be $ 20,000 The marginal tax rate is expected to be 30% after Tax Operating Cash Flow$ 190,000 Less After Tax Depreciation ($10,000 x (1 . 30)) ( 7,000) Debt Redemption Payment (40,000) New Investments (20,000) Free Cash Flow$ 123,000 Discount Rate like a shot that we redeem several(prenominal) idea of our income stream for valuing the Target Company, we need to plant the discount rate for calculating present values. The discount rate used should match the risk associated with the bump cash flows. If the expected guiltless cash flows are exceedingly uncertain, this increases risk and increases the discount rate.The riskier the investment, the mellow the discount rate and vice versa. Another guidance of looking at this is to ask yourself What rate of return do investors require for a selfsame(prenominal) sign of investment? Since valuation of the targets equity is often the objective within the valuation process, it is useful to focus our attention on the targeted capi tal grammatical construction of the Target Company. A review of comparable firms in the marketplace screwing back up find out targeted capital expressions. Based on this capital structure, we nooky guess an overall charge average cost of capital (WACC).The WACC go forth serve as our base for discounting the stark cash flows of the Target Company. primary Applications Valuing a target company is more or less an address of what we greet from capital budgeting. If the Net Present jimmy of the investment is positive, we add value through a merger and acquisition. Example 5 bode Net Present grade Shannon Corporation is considering acquiring Dalton Company for $ 100,000 in cash. Daltons cost of capital is 16%. Based on market epitome, a targeted cost of capital for Dalton is 12%. Shannon has estimated that Dalton skunk generate $ 9,000 of free cash flows over the next 12 age.Using Net Present Value, should Shannon acquire Dalton? Initial Cash Outlay$ (100,000) FCF of $ 9,000 x 6. 1944 * 55,750 Net Present Value $ ( 44,250) * present value factor of annuity at 12%, 12 years. Based on NPV, Shannon should not acquire Dalton since thither is a veto NPV for this investment. We overly need to remember that some acquisitions are related to physiologic assets and some assets whitethorn be sold after the merger. Example 6 encrypt Net Present Value Bishop Company has decided to sell its business for a gross gross sales price of $ 50,000. Bishops Balance Sheet discloses the chase Cash$ 3,000 Accounts Receivable 7,000Inventory 12,000 Equipment Dye 115,000 Equipment Cutting 35,000 Equipment Packing 30,000 gibe Assets$ 202,000 Liabilities 80,000 paleness 122,000 Total Liab & Equity$ 202,000 Allman Company is interested in acquiring devil assets Dye and Cutting Equipment. Allman intends to sell all remaining assets for $ 35,000. Allman estimates that radical future free cash flows from the dye and cutting equipment bequeath be $ 26,000 per year over the next 8 years. The cost of capital is 10% for the associated free cash flows. Ignoring taxes, should Allman acquire Bishop for $ 50,000? Amount Paid to Bishop$ (50,000)Amount collectible Creditors (80,000) Less Cash on Hand 3,000 Less Cash from exchange of Assets 35,000 Total Initial Cash Outlay$ (92,000) Present Value of FCFs for 8 years at 10% $ 26,000 x 5. 3349 138,707 Net Present Value (NPV)$ 46,707 Based on NPV, Allman should acquire Bishop for $ 50,000 since there is a positive NPV of $ 46,707. A solid estimation of incremental changes to cash flow is critical to the valuation process. Because of the variability of what displace happen in the future, it is useful to run cash flow estimates through sensitivity digest, using different changeables to assess what if face epitome.Probability distri only ifions are used to assign values to minglight-emitting diode variables. disguise analysis back tooth be used to evaluate estimates that are more complicated. Va luation Standards Before we get into the valuation calculation, we should recognize valuation standards. Most of us are reasonably aware that superior generally Accepted accounting Principles (GAAP) are used as standards to guide the preparation of financial statements. When we calculate the value (appraisal) of a company, there is a set of standards known as Uniform Standards of Professional Appraisal Practice or USAAP. USAAPs are humpd by the Appraisals Standards mature.Here are some examples To avoid misuse or misinterpret when Discounted Cash Flow (DCF) analysis is used in an appraisal appellative to estimate market value, it is the responsibility of the appraiser to ensure that the controlling infix is pursuant(predicate) with market evidence and prevailing attitudes. Market value DCF analysis should be supported by market derived selective information, and the assumptions should be both market and property specific. Market value DCF analysis is intended to reflect th e expectations and perceptions of market participants along with available factual data.In developing a strong property appraisal, an appraiser must (a) be aware of, understand, and correctly use up those recognized methods and techniques that are obligatory to produce a creditable appraisal (b) not commit a substantial error of omission or co-omission that significantly pretends an appraisal (c) not render appraisal services in a careless or negligent manner, such as a series of errors that considered indivi triplexly may not significantly affect the upshot of an appraisal, but which when considered in aggregate would be misleading. Another area that can create some confusion is the definition of market value.This is particularly strategic where the Target Company is cloak-and-dagger (no market exists). batch mixed in the valuation process sometimes refer to IRS Revenue Ruling 59-60 which defines market value as The price at which the property could change r individually between a leave aloneing geter and a leading seller when the former is not under any compulsion to bargain and the last mentioned is not under any compulsion to sell, both parties having reasonable experience of relevant facts. A net exam point about valuation standards concerns victor certification. Two programs directly related to valuations are CertifiedValuation analyst (CVA) and Accredited in Business Valuations (ABV). The CVA is administered by the National draw of CVAs (www. nacva. com) and the ABV is administered by the American Institute of Certified Public Accountants (AICPA www. aicpa. org). Enlisting throng who carry these professional designations is gameyly recommended. Chapter 5 The Valuation Process We work set the stage for valuing the Target Company. The overall process is centered rough free cash flows and the Discounted Cash Flow (DCF) Model. We forget now focus on the finer points in calculating the valuation.In the book Valuation Measuring and Managing the Value of Companies, the authors Tom Copland, Tim Koller, and Jack Murrin outline five steps for valuing a company 1. Historical Analysis A detail analysis of past feat, including a determination of what drives implementation. some(prenominal) financial calculations need to be made, such as free cash flows, return on capital, etc. dimension analysis and benchmarking are withal used to localize trends that leave aloneinging carry forward into the future. 2. Performance bet It provideing be necessary to estimate the future financial mathematical process of the target company.This requires a attain place understanding of what drives performance and what synergies are expected from the merger. 3. Estimate Cost of Capital We need to determine a weighed average cost of capital for discounting the free cash flows. 4. Estimate pole Value We will add a terminal value to our promise period to account for the time beyond the portend period. 5. Test & Interpret Res ults Finally, once the valuation is reckon, the resultant roles should be time-tested against independent sources, revised, finalized, and presented to old forethought. Financial Analysis We start the valuation process with a sleep unneurotic analysis of historic erformance. The valuation process must be rooted in factual evidence. This historical evidence includes at least the last five years (preferably the last ten years) of financial statements for the Target Company. By analyzing past performance, we can develop a lineation or conclusion about the Target Companys future expected performance. It is also all important(predicate) to gain an understanding of how the Target Company generates and invests its cash flows. One obvious place to start is to assess how the merger will affect earnings. P / E Ratios (price to earnings per share) can be used as a rough indicator for assessing the pretend on earnings.The high the P / E Ratio of the acquiring firm compared to the targ et company, the commodiouser the increase in Earnings per Share (EPS) to the acquiring firm. Dilution of EPS occurs when the P / E Ratio Paid for the target exceeds the P / E Ratio of the acquiring company. The surface of the targets earnings is also important the larger the targets earnings are coition to the acquirer, the greater the increase to EPS for the combined company. The following examples will illustrate these points. Example 7 place Combined EPS Greer Company has plans to acquire Holt Company by exever-changing stock. Greer will issue 1. shares of its stock for distributively share of Holt. Financial t each(prenominal)ing for the two companies is as follows Greer Holt Net Income$ 400,000 $ 100,000 Shares Outstanding 200,000 25,000 Earnings per Share$ 2. 00$ 4. 00 Market Price of Stock$ 40. 00$ 48. 00 Greer expects the P / E Ratio for the combined company to be 15. Combined EPS = ($ 400,000 + $ 100,000) / (200,000 shares + (25,000 x 1. 5)) = $ 500,000 / 237,500 = $ 2. 11 Expected P / E Ratio x 15 Expected Price of Stock$ 31. 65 Before we move to our next example, we should explain exchange ratios.The exchange ratio is the number of shares rendered by the acquiring company in relation to each share of the Target Company. We can calculate the exchange ratio as Price Offered by acquiring Firm / Market Price of Acquiring Firm Example 8 Determine Dilution of EPS Romer Company will acquire all of the outstanding stock of Dayton Company through an exchange of stock. Romer is crack $ 65. 00 per share for Dayton. Financial education for the two companies is as follows Romer Dayton Net Income$ 50,000 $ 10,000 Shares Outstanding 5,000 2,000Earnings per Share$ 10. 00$ 5. 00 Market Price of Stock$ 150. 00 P / E Ratio 15 1) Calculate shares to be issued by Romer $ 65 / $ 150 x 2,000 shares = 867 shares to be issued. 2) Calculate Combined EPS ($ 50,000 + $ 10,000) / (5,000 + 867) = $ 10. 23 3) Calculate P / E Ratio Paid Price Offered / EPS of Target or $ 65. 00 / $ 5. 00 = 13 4) Compare P / E Ratio Paid to current P / E Ratio Since 13 is less than the current ratio of 15, there should be no dilution of EPS for the combined company. 5) Calculate maximum price in the beginning dilution of EPS 15 = price / $ 5. 0 or $ 75. 00 per share. $ 75. 00 is the maximum price that Romer should pay before EPS are diluted. It is important to note that we do not want to get overly pre-occupied with earnings when it comes to financial analysis. Most of our attention should be directed at drivers of value, such as return on capital. For example, free cash flow and economic value added are much more important drivers of value than EPS and P / E Ratios. Therefore, our financial analysis should determine how does the target company create value does it come from equity, what capital structure is used, etc.?In order to answer these questions, we need to 1. Calculate value drivers, such as free cash flow. 2. Analyze the results, looking for trends and compare the results to other companies. 3. Looking back historically in order to ascertain a public take of performance. 4. Analyzing the details to uncover how the Target Company creates value and noting what changes begin taken place. Value Drivers Three core financial drivers of value are 1. Return on Invested Capital (NOPAT / Invested Capital) 2. Free Cash Flows 3. Economic Value Added (NOPAT Cost of Capital) NOPAT Net Operating Profits After TaxesA value driver can represent any variable that affects the value of the company, ranging from great client service to innovative products. erst we capture identified these value drivers, we gain a solid understanding about how the company functions. The headstone is to have these value drivers fit between the Target Company and the Acquiring Company. When we have a good fit or alignment, vigilance will have the ability to influence these drivers and generate higher(prenominal) values. In the book Valuation Measuring and Managin g the Value of Companies, the authors break smoo and so value drivers into three categoriesType of Value DriverManagements Ability to Influence direct 1 GenericLow Level 2 Business UnitsModerate Level 3 OperatingHigh For example, sales revenue is a generic value driver (level 1), customer mix would be a business unit value driver (level 2), and customers kept up(p) would be an operating value driver (level 3). Since value drivers are inter-related and since management will have more influence over level 3 drivers, the key is to ascertain if the merger will give management more or less influence over the operating value driver.If yes, and so a merger and acquisition could lead to revenue or spending synergies. Be advised that you should not work in reverse order i. e. from level 1 down to level 3. For example, an increase in sales set will add more value to level 1, but in the long-run you will hurt customers preserveed (level 3) and thus, you may end-up destroying value. O nce we have identified value drivers, we can develop a strategical view of the Target Company. This strategic view along with drivers of value must be considered in making a performance forecast of the Target Company. We want to know how will the Target Company perform in the future.In order to answer this question, we must have a pop off understanding of the advantages that the Target Company has in relation to the competition. These competitive advantages can include things like customer mix, brand names, market share, business processes, barriers to competition, etc. An understanding of competitive advantages will give us insights into future expected proceeds for the Target Company. Forecasting Performance Now that we have some insights into future produce, we can develop a set of performance scenarios. Since no-one can accurately predict the future, we should develop at least three performance scenarios . Conservative Scenario Future exploitation will be slow and turn awa y over time. 2. General Industry Scenario Continued moderate growth similar to the overall industry. 3. Improved addition Scenario Management has the ability to influence level 1 value drivers and we can expect above average growth. harbour in mind that performance scenarios have a lot of assumptions and some(prenominal) of these assumptions are based on things like future competition, sensitive technologies, changes in the economy, changes in consumer behavior, etc. The end-result is to arrive at a about apt(predicate) value between the different scenarios.Example 9 Overall Value per Three Scenarios You have calculated three Net Present Values (NPV) over a 12 year forecast period. Based on your analysis of value drivers, strategies, competition, and other variables, you have assigned the following values to each scenario ScenarioProbability xNet Present Value =Expected Value Conservative 20% $ 180,000$ 36,000 formula 65% 460,000 299,000 M & A Growth 15% 590,000 88,500 Over all Value of Target Company$ 423,500 The Valuation Model should include a hit set of forecasted financial statements.Usually a set of forecasted financial statements will start with the Sales Forecast since sales is a driver slow many account balances. A good sales forecast will reflect future expected changes in sales prices, volumes, and other variables. stigmatize For more information about preparing forecasted financial statements, refer to Short Course 2 Financial computer programmening & Forecasting. Two important points when preparing your forecast are Historical Perspective fake sure the pieces of your forecast fit together and flow from historical performance. Historical values are very important for predicting the future.You can gain an historical perspective by simply plotting financial trends (see Example 10). Forecast Period Your forecast period should cover a long enough period for the target company to reach a permanent and consistent performance level. For exa mple, a company has reached a stable point when it can earn a unvaried quantity rate of return on capital for an indefinite period and the company has the ability to reinvest a constant proportion of earnings back into the business. Rarely is the forecast period less than seven years. When in doubt, use a longer forecast than a shorter forecast.The final step in forecasting the financials is to estimate the value drivers and verify the value drivers against historical facts. As we indicated, three core drivers are return on capital, free cash flow, and economic value added. Make sure you test your results are key drivers consistent with what has happened in the past, what are the trends for future growth, what are the competitive trends, how will this impact performance, etc.? Example 10 Plotting Historical Trends to help with preparing forecasted financial statements 1990 1991 1992 1993 1994 OperationsGrowth in Revenues 14% 12% 11% 11% 10% Growth in Margins 7% 7% 6% 5% 5% Working Capital Cash 2% 2% 2% 3% 3% Accts Rec 12% 13% 13% 13% 14% Accts Payable 4% 4% 5% 5% 5% Investments Assets to Sales 30% 31% 28% 29% 28% Return on Capital 14% 12% 13% 13% 12% When we have completed the Valuation Model, we will have a set of forecasted financial statements supporting each of our scenarios Forecasted Income instruction 3 Scenarios ? Forecasted Balance Sheet 3 Scenarios ? Forecasted Free Cash Flows 3 Scenarios ? Forecasted Return on Capital 3 Scenarios ? Forecasted Performance Ratios 3 Scenarios Example 11 Forecasted Income Statement for Scenario 2 Moderate ($ million) 2001 2002 2003 2004 2005 2006 2007 Revenues $ 6. 50$ 6. 70 $ 6. 85 $6. 95 $7. 05 $7. 09 $7. 12 Less Operating 3. 20 3. 30 3. 41 3. 53 3. 65 3. 72 3. 78 Less Depreciation . 56 . 54 . 2 . 85 . 80 . 77 . 72 EBIT 2. 74 2. 86 2. 92 2. 57 2. 60 2. 60 2. 62 Less Interest . 405 . 380 . 365 . 450 . 440 . 410 . 390 Earnings Before Tax 2. 335 2. 480 2. 555 2. 12 2. 16 2. 19 2. 23 Less Taxes . 780 . 810 . 870 . 650 . 660 . 71 . 73 Net Income 1. 555 1. 670 1. 685 1. 470 1. 500 1. 48 1. 50 rod Values It is quite possible that free cash flows will be generated well beyond our forecast period.Therefore, many valuations will add a terminal value to the valuation forecast. The terminal value represents the total present value that we will lift up after the forecast period. Example 12 Adding Terminal Value to Valuation Forecast Net Present Value for forecast period (Example 9) $ 423,500 Terminal Value for beyond forecast period 183,600 Total NPV of Target Company$ 607,100 There are several approaches to calculating the terminal value Dividend Growth Simply take the free cash flow in the final year of the forecast, add a nominal growth rate to this flow and discount the free cash flow as a perpetuity.Terminal value is calculated as Terminal Value = FCF ( t + 1 ) / wacc g ( t + 1 ) refers to the first year beyond the forecast period wacc weighted average cost of capital g growth rate, normal ly a very nominal rate similar to the overall economy It should be noted that FCF used for calculating terminal values is a normalized free cash flow (FCF) representative of the forecast period. Example 13 Calculate Terminal Value Using Dividend Growth You have prepared a forecast for ten years and the normalized free cash flow is $ 45,000. The growth rate expected after the forecast period is 3%.The wacc for the Target Company is 12%. ($ 45,000 x 1. 03) / (. 12 . 03) = $ 46,350 / . 09 = $ 515,000 If we wanted to shut out the growth rate in Example 13, we would calculate terminal value as $ 46,350 / . 12 = $ 386,250. This gives us a much more nonprogressive estimate. correct Growth Growth is included to the extent that we can generate returns higher than our cost of capital. As a company grows, you must reinvest back into the business and thus free cash flows will fall. Therefore, the Ad equitableed Growth approach is one of the more appropriate models for calculating terminal values.Terminal Value = EBIT ( 1 tr) ( 1 g / r ) / wacc g tr tax rateg growth rater rate of return on refreshing investments Example 14 Calculate Terminal Value Using Adjusted Growth Normalized EBIT is $ 60,000 and the expected normal tax rate is 30%. The overall long-term growth rate is 3% and the weighted average cost of capital is 12%. We expect to concord a rate of return on stark naked investments of 15%. $ 61,800 ( 1 . 30 ) ( 1 . 03 / . 15 ) / (. 12 . 03) = $ 43,260 ( . 80 ) / . 09 = $ 384,533 If we use Free Cash Flows, we would have the following type of calculationEarnings Before Interest Taxes (EBIT)$ 60,000 Remove taxes (1 tr ) x . 70 Operating Income After Taxes 42,000 Depreciation (non cash item) 12,000 Less Capital Expenditures ( 9,000) Less Changes to Working Capital ( 1,000) Free Cash Flow 44,000 Growth Rate 3% x 1. 03 Free Cash Flow ( t + 1 ) 45,320 Adjust Growth Return on Capital x . 80 Adjusted FCF ( t + 1 ) 36,256 Divided by wacc g or . 12 . 03 . 09 Terminal Value$ 402,844 EVA Approach If your valuation is based on economic value added (EVA), then you should extend this concept to your terminal value calculationTerminal Value = NOPAT ( t + 1 ) x ( 1 g / rc ) / wacc g NOPAT Net Operating Profits After Taxesrc return on invested capital Terminal values should be calculated using the same basic model you used within the forecast period. You should not use P / E multiples to calculate terminal values since the price paid for a target company is not derived from earnings, but from free cash flows or EVA. Finally, terminal values are appropriate when two conditions exist 1. The Target Company has consistent profitability and turnover of capital for generating a constant return on capital. . The Target Company is able to reinvest a constant level of cash flow because of consistency in growth. If these two criteria do not exist, you may need to consider a more conservative approach to calculating terminal value or simply exclude the terminal value altogether. Example 15 Summarize Valuation Calculation Based on Expected Values under Three Scenarios Present Value of FCFs for 10 year forecast period$ 62,500 Terminal Value based on Perpetuity 87,200 Present Value of Non Operating Assets 8,600 Total Value of Target Company 158,300Less Outstanding Debt at funfair Market Value Short-Term Notes Payable ( 6,850) Long-Term Bonds (25 year manakin BB) ( 26,450) Long-Term Bonds (10 year division AAA) ( 31,900) Long-Term Bonds ( 5 year Grade BBB) ( 22,700) Present Value of Lease Obligations ( 17,880) Total Value Assigned to Equity 52,520 Outstanding Shares of Stock 7,000 Value per Share ($ 52,520 / 7,000)$ 7. 50 Example 16 Calculate Value per Share You have completed the following forecast of free cash flows for an eight year period, capturing the normal business speech rhythm of Arbor Company Year FCF 2001$ 1,550 002 1,573 2003. 1,598 2004. 1,626 2005. 1,656 2006. 1,680 2007. 1,703 2008. 1,725 Arbor has non-operating assets of $ 150. These assets have an estimated present value of $ 500. Based on the present value of future payments, the present value of debt is $ 2,800. Terminal value is calculated using the dividend growth model. A nominal growth rate of 2% will be used. Arbors targeted cost of capital is 14%. Arbor has 3,000 shares of stock outstanding. What is Arbors Value per Share? Year FCF x P. V. 14%Present Value 2001$ 1,550. 8772$ 1,360 2002 1,573. 7695 1,210 003. 1,598. 6750 1,079 2004. 1,626. 5921 963 2005. 1,656. 5194 860 2006. 1,680. 4556 765 2007. 1,703. 3996 681 2008. 1,725. 3506 605 Total Present Value for Forecast Period $ 7,523 Terminal Value = ($ 1,725 x 1. 02) / (. 14 . 02) = 14,663 Value of Non Operating Assets 500 Total Value of Arbor 22,686 Less Value of Debt( 2,800) Value of Equity 19,886 Shares Outstanding 3,000 Value per Share$ 6. 63 Special conundrums Before we leave valuations, we should note some special worrys that can influence the valuation calculation.Privat e Companies When valuing a private company, there is no marketplace for the private company. This can coif comparisons and other analysis very difficult. Additionally, complete historical information may not be available. Consequently, it is communal practice to add to the discount rate when valuing a private company since there is much more uncertainty and risk. Foreign Companies If the target company is a extraneous company, you will need to consider several additional variables, including translation of contradictory currencies, differences in regulations and taxes, lack of good information, and political risk.Your forecast should be consistent with the inflation rates in the abroad country. Also, look for hidden assets since foreign assets can have significant differences between book values and market values. shade Control If the target company agrees to relinquish complete and total control over to the acquiring firm, this can increase the value of the target. The value a ssigned to control is expressed as CV = C + M CV Controlling Value C Maximum price the buyer is willing to pay for control of the target company M minority Value or the present value of cash flows to minority shareholders.If the merger is not expected to result in enhanced values (synergies), then the acquiring firm cannot justify paying a price above the minority value. Minority value is sometimes referred to as stand-alone value. Chapter 6 gage Merger desegregation We have now reached the fifth and final phase within the merger and acquisition process, desegregation of the two companies. Up to this point, the process has center on putting a deal together. Now comes the hard part, making the merger and acquisition work. If we did a good chew over with due diligence, we should have the foundation for post merger desegregation.However, despite due diligence, we will need to address a multitude of issues, such as ? Finalizing a common strategy for the bleak organization. We ne ed to be prudent not to impose one strategy onto the other company since it may not fit. ? Consolidating duplicative services, such as human resources, finance, legal, etc. ? Consolidating payment plans, in incarnate policies, and other operating procedures. ? Deciding on what level of integrating should take place. ? Deciding on who will govern the young organization, what authority community will have, etc.It is ironic that in many cases, senior management is actively involved in putting the merger together, but once everything has been finalized, the job of integrating the two companies is dumped on middle level management. Therefore, one of the first things that should happen within post merger integration is for senior management to ? Develop an overall plan for integrating the two companies, including a time frame since synergy values need to be vulcanized chop-chop. If synergy values are dependent upon the targets customers, markets, assets, etc. , then a fast integr ation process should be planned.If expected synergies come from strategies and dexterous capital of the target, a more cautious approach to integration may be appropriate. ? Directing and guiding the integration process, establishing governance, and charge project managers to integration projects. ? Leading change through great discourse, bringing concourse together, resolving power issues before they magnify, establishing expectations, etc. Once the two companies announce their merger, an entire set of dynamics goes into motion. Uncertainty and change suddenly impact both companies. Several issues need to be managed to prevent the escape of synergy values.Managing the Process The integration of two companies is managed within a single, centralized structure in order to snub duplication and belittle confusion. A centralized structure is also needed to pull everything together since the integration process tends to create a lot of divergent forces. A superior Project Team wil l be responsible for managing post merger integration (PMI). This includes things like coordination of projects, assigning task, providing support, etc. As previously indicated, it is important for both senior management and middle management to share in the integration processSenior ManagementSenior Project Team heathen & Social IntegrationFunctional Integration Strategic befit between the CompaniesSelection of Best Practices CommunicationSet up labour Forces Identify detai guide Issues Problem Solving The Senior Project Team will consist of representatives from both companies, covering several functional areas (human resources, marketing, operations, finance, etc. ). Team members should have a very strong understanding of the business since they are trying to capture synergy values throughout PMI.Special task forces will be schematic by the Senior Project Team to integrate various functions (finance, information technology, human resources, etc. ). Task forces are also used t o address specific issues, such as customer retention, non-disruption of operations, retention of key personnel, etc. Task forces can create sub-teams to split an issue by geographic area, product line, etc. All of these teams must have a clear understanding of the reasons behind the merger since it is everybodys job to capture synergies.There is no way senior management can fully identify all of the expected synergies from a merger and acquisition. It is not unusual for some task forces to begin meeting before the merger is announced. If integration begins before announcement of the merger, team members will have to act in a confidential manner, exercising care on who they share information with. The surmount approach is to act as though a merger will not take place. Example 17 Timeline leading up to comport Merger Integration (PMI) June 21, 1998 Officers from both companies plan post merger integration.July 17, 1998 taste meeting for key management personnel from both companie s. July 30, 1998 Project passenger cars are assigned to Task Forces. August 16, 1998 Launch Task Forces. August 27, 1998 Critical Issues are identified by Task Forces. Set goals and time frames. October 26, 1998 Task Force develops detail plan for PMI. October 30, 1998 Reach consensus on final plan. November 6, 1998 Officers from both companies approve detail integration plans. November 11, 1998 Operating (action steps) are outlined for implementing the PMI Plan. January 17, 1999 get Post Merger IntegrationExample 18 Outline for Post Merger Integration (PMI) by Senior Task Force or Senior Project Team 1. Assess current situation where do we stand? 2. Collect information and identify critical issues for integration. 3. Develop plans to resolve critical issues. 4. Obtain consensus and agree on PMI Plan. 5. Train personnel, prepare for integration, work out logistics, map out the process, etc. 6. Implement PMI Plan allot meetings, setup teams, provide direction, make key decision s, etc. 7. Revise the PMI Plan measure and monitor progress, make adjustments, issue progress fields to executive management, etc. . Delegate Move the integration process down into lower levels of the organization, allow staff personnel to control certain integration decisions, etc. 9. Complete Move aggressively into full integration, coordinate and communicate progress until integration is complete. Decision Making Post merger integration (PMI) will require very quick decision-making. This is due in part to the fact that fast integrations work offend than slow integrations. The new organization has to be established quickly so good deal can get back to inspection and repair customers, designing products, etc.The more time population spend intellection about the merger, the less likely they will perform at high levels. Many decisions within PMI will be difficult, such as establishing the new organizational structure, re-assigning personnel, selling-off assets, etc. However, it is necessary to get these decisions behind you as quickly as possible since the synergy meter is rill. In addition, split upure to act will leave the impression of indecisiveness and inability to manage PMI. In order to make decisions, it is necessary to define roles wad need to know who is in charge.People who are responsible for integration should be highly skilled in coordinating projects, leading mass, and thinking on their feet bandage staying focused on the strategies behind the merger and acquisition. People Issues Productivity and performance will usually drop once a merger is announced. The reason is simple great deal are concerned about what will happen. In the book The Complete Guide to Mergers and Acquisitions, the authors note that at least 360,000 hours of lost(p) productivity can be lost during an acquisition of just a thousand person operation. Quick and open communication is essential for managing multitude issues.Constant communication is required for addressing the rumors and questions that arise within PMI. People must know what is going on if they are expected to remain focused on their jobs. Communication should be deep and broad, reaching out to as many people as possible. Face to face communication whole kit and caboodle opera hat since there is an opportunity for feedback. Even cursory communication is better than no communication at all. Get all the facts out. Give people the rationale for change, laying it out in the clearest, most dramatic terms. When everybody gets the same facts, theyll generally come to the same conclusion.Only after everyone agrees on the man and fortress is lowered can you get buy-in to the needed changes. Jack Welch, CEO, General Electric It is also a good idea to train people in change management. Most people will lack the knowledge and skills required for PMI. Immediately after the merger is announced, key personnel should receive training in how to manage change and make quick decisions. People must feel competent about their abilities to pull off the integration. Managing subway system The failure to manage resistance is a major reason for failed mergers. apology is natural and not necessarily indicative of something wrong.However, it cannot be ignored. Four important to a faultls for managing resistance are Communicate As we just indicated, you have to make sure people know what is going on if you expect to minimize resistance. Rumors should not be the main form of communication. The following quote from a middle level manager at a meeting with executive management says it all How can I tell my people what necessarily to be done to integrate the two companies, when I have comprehend nothing about what is going on. Training As we just noted, people must possess the necessary skills to manage PMI.Investing in people through training can help achieve buy-in and thus, lower resistance. amour Resistance can be reduced by including people in the decision making p rocess. Active engagement can also help identify problem areas. Alignment One way to buffer against resistance is to align yourself with those people who have accepted the merger. Ultimately, it will be the non-resistors who bring about the integration. Do not waste excessive resources on detractors they will never come around. Closing the Cultural Gap One of the biggest challenges within PMI is to close the cultural divide between the two companies.Cultural differences should have been identified within Phase II Due Diligence. One way of closing the cultural gap is to invent a third, new corporate culture as opposed to forcing one culture onto another company. A re-design approach can include ? Reducing the number of rules and policies that control people. In to daylights empowered world, it has become important to unleash the human capacities within the organization. ? give rise a set of corporate policies centered around the strategic goals and objectives of the new organization . ? Implement new innovative approaches to human resource management, such as the 360-degree evaluation. Eliminate various forms of communication that continue with the old way of doing things. ? Re-enforce the new ways with incentive programs, rewards, recognition, special events, etc. Specific Areas of Integration As we move forward with the integration process, a new organizational structure will unfold. There will be new reporting structures based on the of necessity of the new company. Structures are built around workflows. For best results, collaboration should take place between the two companies mixing people, combination offices, sharing facilities, etc. This collaboration helps pull the new organization together.As noted earlier, a centralized organization will experience less difficulty with PMI than a decentralized organization. Collaboration is also enhanced when there are ? Shared Goals The more common the goals and objectives of the two companies, the easier it is t o integrate the two companies. ? Shared Cultures The more common the cultures of the two companies, the easier the integration. ? Shared function The scalelike both companys can come to developing a set of shared out services (human resource management, finance, etc. ), the more likely synergies can be realized through elimination of duplicative services.Many functional areas will have to be integrated. Each will have its own integration plan, led by a Task Force. Two areas of concern are compensation and technologies. Compensation Plans It is important to make compensation plans between the two companies as uniform as possible. Failure to close the compensation gap can lead to division within the workforce. Compensation plans should be intentional based on a balance between past practices and future call for of the company. Since lost productivity is a major issue, compensation based on performance should be a major focus.Technologies When deciding which information system t o keep between the two companies, make sure you ask yourself the following questions ? Do we really need this information? ? Is the information timely? ? Is the information accurate? ? Is the information accessible? One of the misconceptions that may emerge is to hold on the most current, leading-edge technology. This may be a mistake since older bequest systems may be well tested and reliable for future needs of the organization. If both systems between the two companies are outdated, a whole new system may be required. Retaining Key PersonnelMergers often result in the loss of key (essential) personnel. Since synergies are highly dependent upon note personnel, it will be important to take steps for retaining the high performers of the Target Company. The first step is to identify key personnel. Ask yourself, if these people were to leave, what impact would it have on the company? For example, suppose a Marketing Manager decided to resign, resulting in the loss of critical custom ers. Other people may be critical to strategic thinking and innovation. Once you have a list of key personnel, the next step is to determine what motivates essential personnel. several(prenominal) people are prompt by their work man others are interested in climbing the corporate ladder. Retention programs are designed around these motivating factors. The third step is to implement your retention programs. in person communicate with key personnel let them know what their position will be in the new company. If compensation is a motivating factor, offer key personnel a stay bonus. If people are motivated by career advancement, invite them to important management meetings and have them go in in decision making.Dont forget to reinforce retention by recognizing the contributions made by key personnel. It is also a good idea to embark key personnel just as if you would recruit any other key management position. This solidifies the retention process. Finally, you will need to evaluate and qualify retention programs. For example, if key people continue to resign, then conduct an tone ending interview and find out why they are leaving. Use this information to change your retention programs otherwise, more people will be defecting. Retaining Customers Mergers will obviously create some disruptions.One area where disruptions must be minimized is customer service. Once a merger is announced, communicate to your customers, communicate them that products and services will not deteriorate due to the merger. Additionally, employees directly involved with customer service cannot be distracted by the merger. If customers are expected to defect, consider offering special deals and programs to reinforce customer retention. As a minimum, consider setting up a customer hotline to answer questions. Finally, do not forget to communicate with vendors, suppliers, and others involved in the value chain.They too are your customers. Measuring PMI The last area we want to touch on is step of post merger integration (PMI). Results of the integration process need to be captured and measured so that you can identify problem areas and make corrections. For example, are we able to retain key personnel? How effective is our communication? We need answers to these types of questions if we expect winner in PMI. One way of ensuring feedback is to retain the current measurement systems that are in place especially those involved with critical areas like customer service and financial reporting.Day to day operations will need to be monitored for sudden changes in customer complaints, return merchandise, cancelled orders, production stoppages, etc. New measurements for PMI will have to be simple and easy to deploy since there is little time for formal design. For example, in one case the PMI relied on a web site log to capture critical data, identify synergy projects, and report PMI progress. On-line survey forms were used to solicit input and identify problem areas. A clean and simple approach works best. A measurement system starts with a list of critical success factors (CSF) related to PMI.These CSFs will reflect the strategic outcomes associated with the merger. For example, combining two overlapping business units talent represent a CSF for a merger. From these CSFs, we can develop key performance indicators. Collectively, a complete system known as the Balanced menu can be used to monitor PMI. Process leaders are assigned to each perspective within the scorecard, collecting the necessary data for measurement. Example 19 Balanced Scorecard for Post Merger Integration (PMI) PerspectiveKey Performance Indicator Customers- Retention of Existing Customers Efficiency in Delivering Services Financial- Synergy Components Captured to Date - Timely Financial Reporting - Timely Cash Flow Management Operational- Completion of Systems Analysis - Reassignments to all Operating Units - Resources Allocated for Workloads charitable Resource- Percentage of Personnel Defections - Change Management Training - Communication Feedbacks Organizational- Cultural Gaps between companys - Number of Critical Processes Defined - Lower level troth in integration Chapter 7Anti-Takeover self-abnegations Throughout this entire short course ( move 1 & 2), we have focused our attention on making the merger and acquisition process work. In this final chapter, we will do just the opposite we will look at ways of discouraging the merger and acquisition process. If a company is concerned about being acquired by another company, several anti-putsch defenses can be implemented. As a minimum, most companies concerned about takeovers will closely monitor the trading of their stock for large volume changes. Poison Pills One of the most popular anti-takeover defenses is the acerbate pill.Poison pills represent rights or options issued to shareholders and bondholders. These rights trade in conjunction with other securities and they usually have an expirati on date. When a merger occurs, the rights are set-apart from the security and exercised, giving the holder an opportunity to buy more securities at a deep discount. For example, stock rights are issued to shareholders, giving them an opportunity to buy stock in the acquiring company at an extremely low price. The rights cannot be exercised unless a tender offer of 20% or more is made by another company. This type of issue is designed to reduce the value of the Target Company.Flip-over rights provide for purchase of the Acquiring Company while flip-in rights give the shareholder the right to acquire more stock in the Target Company. Put options are used with bondholders, allowing them to sell-off bonds in the event that an inimical takeover occurs. By selling off the bonds, large principal payments come due and this lowers the value of the Target Company. Golden Parachutes Another popular anti-takeover defense is the Golden Parachute. Golden parachutes are large compensation payme nts to executive management, payable if they depart unexpectedly. Lump sum payments are made upon termination of employment.The count of compensation is usually based on annual compensation and years of service. Golden parachutes are narrowly applied to only the most elite radical executives and thus, they are sometimes viewed negatively by shareholders and others. In relation to other types of takeover defenses, specious parachutes are not very effective. Changes to the Corporate plight If management can obtain shareholder approval, several changes can be made to the Corporate Charter for discouraging mergers. These changes include Staggered Terms for Board Members Only a few board members are elected each year.When an acquiring firm gains control of the Target Company, important decisions are more difficult since the acquirer lacks full board membership. A staggered board usually provides that one-third are elected each year for a 3 year term. Since acquiring firms often gain c ontrol directly from shareholders, staggered boards are not a major anti-takeover defense. Super-majority Requirement Typically, simple majorities of shareholders are required for various actions. However, the corporate charter can be amended, requiring that a super-majority (such as 80%) is required for approval of a merger.Usually an escape article is added to the charter, not requiring a super-majority for mergers that have been approved by the Board of Directors. In cases where a partial tender offer has been made, the super-majority requirement can disapprove the merger. Fair Pricing Provision In the event that a partial tender offer is made, the charter can require that minority shareholders receive a fair price for their stock. Since many states have adopted fair pricing laws, inclusion of a fair pricing provision in the corporate charter may be a moot point.However, in the case of a two-tiered offer where there is no fair pricing law, the acquiring firm will be forced to p ay a blended price for the stock. Dual Capitalization Instead of having one caste of equity stock, the company has a dual equity structure. One coterie of stock, held by management, will have much stronger voting rights than the other publicly traded stock. Since management holds superior voting power, management has increased control over the company. A word of caution The SEC no longer allows dual capitalizations although existing plans can remain in effect. RecapitalizationsOne way for a company to avoid a merger is to make a major change in its capital structure. For example, the company can issue large volumes of debt and initiate a self-offer or buy back of its own stock. If the company seeks to buy-back all of its stock, it can go private through a leveraged buy out (LBO). However, leveraged recapitalizations require stable earnings and cash flows for servicing the high debt loads. And the company should not have plans for major capital investments in the dependable future . Therefore, leveraged recaps should stand on their own merits and offer additional values to shareholders.Maintaining high debt levels can make it more difficult for the acquiring company since a low debt level allows the acquiring company to borrow easily against the assets of the Target Company. Instead of issuing more debt, the Target Company can issue more stock. In many cases, the Target Company will have a friendly investor known as a white swell which seeks a quality investment and does not seek control of the Target Company. Once the additional shares have been issued to the white squire, it now takes more shares to obtain control over the Target Company.Finally, the Target Company can do things to boost valuations, such as stock buy-backs and spinning off parts of the company. In some cases, the target company may want to consider liquidation, selling-off assets and paying out a liquidating dividend to shareholders. It is important to emphasize that all restructurings sho uld be directed at change magnitude shareholder value and not at trying to stop a merger. Other Anti Takeover Defenses Finally, if an unfriendly takeover does occur, the company does have some defenses to discourage the proposed merger 1.Stand Still Agreement The acquiring company and the target company can reach agreement whereby the acquiring company ceases to acquire stock in the target for a specified period of time. This stand slake period gives the Target Company time to explore its options. However, most stand still agreements will require compensation to the acquiring firm since the acquirer is running the risk of losing synergy values. 2. Green Mail If the acquirer is an investor or group of investors, it might be possible to buy back their stock at a special offering price.The two parties hold private negotiations and bury for a price. However, this type of targeted repurchase of stock runs contrary to fair and capable treatment for all shareholders. Therefore, green m ail is not a widely accepted anti-takeover defense. 3. White sawhorse If the target company wants to avoid a unconnected merger, one option is to seek out another company for a more suitable merger. Usually, the Target Company will draft the services of an investment banker to locate a white knight. The White Knight Company comes in and rescues the Target Company from the hostile takeover attempt.In order to stop the hostile merger, the White Knight will pay a price more favorable than the price offered by the hostile bidder. 4. Litigation One of the more common approaches to stopping a merger is to legally challenge the merger. The Target Company will seek an requirement to stop the takeover from proceeding. This gives the target company time to mount a defense. For example, the Target Company will routinely challenge the acquiring company as failing to give proper notice of the merger and failing to disclose all relevant information to shareholders. 5.Pac Man Defense As a la st resort, the target company can make a tender offer to acquire the stock of the hostile bidder. This is a very extreme type of anti-takeover defense and usually signals desperation. One very important issue about anti-takeover defenses is valuations. Many anti-takeover defenses (such as poison pills, golden parachutes, etc. ) have a tendency to protect management as opposed to the shareholder. Consequently, companies with anti-takeover defenses usually have less upside potential with valuations as opposed to companies that lack anti-takeover defenses.Additionally, most studies certify that anti-takeover defenses are not undefeated in preventing mergers. They simply add to the premiums that acquiring companies must pay for target companies. Proxy Fights One last point to make about changes in ownership concerns the fact that shareholders can sometimes initiate a takeover attempt. Since shareholders have voting rights, they can attempt to make changes within a company. Proxy fight s usually attempt to transpose management by picking new positions within the Board of Directors. The insurgent shareholder(s) will cast votes to supersede the current board.Proxy fights begin when shareholders request a change in the board. The next step is to solicit all shareholders and allow them to vote by deputy. Shareholders will send in a card to a designated storage battery (usually a broker) where votes are tallied. Some important factors that will influence the success of a proxy fight are 1. The degree of support for management from shareholders not directly involved in the proxy fight. If other shareholders are satisfied with management, then a proxy fight will be difficult. 2. The historical performance of the company.If the company is starting to fail, then shareholders will be much more receptive to a change in management. 3. A specific plan to turn the company around. If the shareholders who are leading the proxy fight have a plan for improving performance and increasing shareholder value, then other shareholders will probably support the proxy fight. Proxy fights are less costly than tender offers in changing control within a company. However, most proxy fights fail to remove management. The upside of a proxy fight is that it usually brings about a boost in shareholder value since management is forced to act on poor performance.It is worth noting that proxy fights are sometimes led by former managers with the Target Company who recognize what needs to be done to turn the company around. In any event, studies clearly show that changes in management are much more likely to occur externally (tender offers) as opposed to internally (proxy fights). Course Summary A merger is like a marriage the two partners must be compatible. Each side should add value so that together the two are much stronger. Unfortunately, many mergers fail to work. Overpaying for the acquisition is a common mistake because of an incomplete valuation model.Therefore, it is essential to develop a complete valuation model, including analysis under different scenarios with recognition of value drivers. A good starting point for determining value is to extend the Discounted Cash Flow Model since it corresponds well to market values. Core value drivers (such as free cash flows) should be emphasized over traditional type earnings (such as EBITDA). Some key points to remember in the valuation process include 1. Most valuations will focus on valuing the equity of the Target Company. 2. The discount rate used should match-up with the associated risk of cash flows. . The forecast should focus on long-term cash flows over a period of time that captures a normal operating cycle for the company. 4. The forecast should be realistic by fitting with historical facts. 5. A comp model is required based on an understanding of what drives value for the company. 6. The final forecast should be tested against independent sources. If pre merger phases are complete, we can move forward to integrate the two companies. This will require the metempsychosis of information systems, combining of workforces, and other projects.Many failures can be traced to people problems, such as cultural differences between the companies, which can lead to resistance. Additionally, if you fail to retain key personnel, the integration process will be much more difficult. The best defense against personnel defections is to have a great place to work. If the company has a bad reputation as an employer, then defections will surely occur. Some of the risk factors associated with post merger integration are 1. What level of integration do we implement? 2. What can we do to retain key personnel? 3. How serious are the cultural differences between the companies? . What kinds of conflicts and competition can we expect during integration? 5. To what extent do the people of both companys understand the merger? 6. Who will govern and control the new company? Success with post me rger integration is remediated when 1. The two companies have a history of effective planning and strategizing. 2. The two companies have a history of successful change management. 3. The merger will improve the strategies