Mergers & Acquisitions January 27 / TA Session / Eric Rinder

General Information Will typically meet for an hour starting at –First Four Weeks: Tuesday 4:20 pm (JG 103) and Wednesday 11:00 am (JG 107), 4:20 pm (JG 104) TA website: –TA session schedule –TA materials Please don’t hesitate to reach out with questions or concerns 1

TA Session Goals Facilitate discussion Provide help with difficult material Help pull course together with an eye towards the exam 2

Merger Agreements Help solve adverse selection problem – Representations and warranties – Securities laws supplement merger agreements for publicly traded companies and IPOs Help solve moral hazard problem – Performance-based compensation Help apportion risk – Material Adverse Change clause: who bears the risk of market collapse? – Financing condition: who bears the risk of financing unavailability? 3

Valuation Under Certainty When risk is removed, all that matters is timing –e.g. $1 today is better than $1 tomorrow Present value is a function of: –The length of time until the money will be received –The discount rate (i.e. the risk free interest rate…U.S. Treasury bills) 4

Capital Budgeting Compare initial capital outlay with present value of future cash flows Allows planners to choose highest value allocation of capital 5

Chapter 2 Problems 1.$ $ $ % 5.Investment 2 6.(a) 33.3% / (b) $15,909 7.Bank A 8.$100,000 today 9.(a) stream of $100 payments / (b) stream of payments 10.Weekly 11.Yearly 12.Must compensate investor for the opportunity cost of forgone investments 6

Problem 1, CB 79 How much must you invest today at 6% to have $1 at the end of one year? Present Value Equation: PV = FV/ (1+r) n – PV = $1 / (1.06) = $.943 PV= Present Value FV= Future Value R= Interest rate N= Number of times compounded 7

Problem 2, CB 79 Assuming rate of interest of 6%, how much do you have in 1 year if you invest $1 today? Terminal Value Equation (annual compounding): – TV = X 0 (1+r) – TV = $1 * (1.06) = $1.06 TV= Terminal value X O = Initial value R= Interest Rate 8

Problem 3, CB 79 What was your initial deposit, assuming an account balance of $ one year later and 12% interest rate? Present Value Equation: PV = FV/ (1+r) n – PV = $ / (1.12) = $

Problem 4, CB 79 If you deposited $734,011 in your bank account and have $756,213 one year later, what is the interest rate? Present Value Equation: – PV = FV/ (1+r) n – r = (FV/PV) – 1 – r = ($756,213/734,011) – 1 =.0302 = 3.02% 10

Problem 5, CB 79 Which project has a higher net present value? Present Value Equation: PV = FV/ (1+r) n In a world without risk, Option 2 has a higher net present value and is a better investment 11 Option 1Option 2 Capital Outlay$250,000 Year 1$300,000$400,000

Problem 6(a), CB 79 What is the rate of return if you invest $75,000 today for a payback of $100,000 in one year? Present Value Equation: – PV = FV / (1 + r) n – r = (FV/PV) – 1 – r = ($100,000/75,000) – 1 =

Problem 6(b), CB 79 Invest $75,000 today for a payback of $100,000 in one year. At a discount rate of 10%, what is the net present value? Present Value Equation: PV = $100,000 / (1.10) = $90,909 NPV = $90,909 - $75,000 = $15,909 13

Problem 7, CB 79 Bank A pays 6% interest compounded annually. Bank B pays 5.8% interest compounded quarterly. Which bank is better? Terminal Value Equation (non-annual compounding): TV = X 0 (1+r/m) m – Bank A ($1 invested for 1 year) TV = $1 * (1.06) = $1.06 – Bank B ($1 invested for 1 year) TV = $1 * ( /4) 4 = $1 * (1.0145) 4 = $ Bank A is better 14

Problem 8, CB 80 If interest rate is 10%, which is better: $100,000 today or $1,000,000 in 25 years? Present Value Equation: PV = FV / (1 + r) n PV = $1,000,000 / (1.10) 25 = $92,296 $100,000 today is better 15

Problem 9(b), CB 80 Option 1: $375 today Option 2: Series of cash flows over time Present Value Equation: PV = FV / (1 + r) n 16 Option 1Option 2 Now$375 Year 1$100 / (1.10) =$ … Year 2$100 / (1.10) 2 =$ … Year 3$100 / (1.10) 3 =$ … Year 4$100 / (1.10) 4 =$ … Year 5$100 / (1.10) 5 =$ … Total$375$379.08

Problem 9(b), CB 80 Option 1: $375 today Option 2: Series of cash flows over time Present Value Equation: PV = FV / (1 + r) n 17 Option 1Option 2 Now$375 Year 1$50 / (1.10) =$ … Year 2$100 / (1.10) 2 =$ … Year 3$100 / (1.10) 3 =$ … Year 4$100 / (1.10) 4 =$ … Year 5$100 / (1.10) 5 =$ … Year 6$100 / (1.10) 6 =$ … Total$375$390.07

Problem 10 and 11, CB 80 Problem 10: Better to be paid weekly, biweekly, or monthly? – Weekly is better because you start receiving money earlier. Problem 11: Better to pay interest monthly, quarterly, or annually? – Terminal Value Equation: TV = X 0 (1+r/m) m – Assuming $100 loan repaid after 1 year: Monthly: TV = $100 (1 +.1/12) 12 = $ Quarterly: TV = $100 (1 +.1/4) 4 = $ Annually: TV = $100 (1 +.1) = $110 – Better to pay annually 18

Problem 12, CB 80 Why would you expect the rate of interest to be greater than zero? – Yes because you must compensate the investor for the opportunity cost of forgone investments. 19