1. APPLYING FINANCIAL MODELS To Value, Structure, and Negotiate Stock and Asset Purchases

2. not witty enough to be sarcastic.
Tact is for people
not witty enough to be sarcastic.
--Anonymous

3. Part IV: Deal Structuring and Financing
Exhibit 1: Course Layout: Mergers, Acquisitions, and Other
Restructuring Activities
Part IV: Deal Structuring and Financing
Part II: M&A Process
Part I: M&A Environment
Ch. 11: Payment and Legal Considerations
Ch. 7: Discounted Cash Flow Valuation
Ch. 9: Financial Modeling Techniques
Ch. 6: M&A Postclosing Integration
Ch. 4: Business and Acquisition Plans
Ch. 5: Search through Closing Activities
Part V: Alternative Business and Restructuring Strategies
Ch. 12: Accounting & Tax Considerations
Ch. 15: Business Alliances
Ch. 16: Divestitures, Spin-Offs, Split-Offs, and Equity Carve-Outs
Ch. 17: Bankruptcy and Liquidation
Ch. 2: Regulatory Considerations
Ch. 1: Motivations for M&A
Part III: M&A Valuation and Modeling
Ch. 3: Takeover Tactics, Defenses, and Corporate Governance
Ch. 13: Financing the Deal
Ch. 8: Relative Valuation Methodologies
Ch. 18: Cross-Border Transactions
Ch. 14: Applying Financial Models to Deal Structuring
Ch. 10: Private Company Valuation

4. Learning Objectives
Through “hands on” application of the author’s M&A model, provide students with a basic understanding of
How such models work for a stock purchase and an asset purchase;
The data input requirements to generate critical model output
How to apply such models to address valuation, financing, and deal structuring questions; and
How they facilitate the assessment of proposals and counterproposals that arise during the negotiation process.

5. Financial Models Help Answer Key Valuation, Financing, and Deal Structuring Questions
What are the key drivers of firm value?
How much is the target company worth without the effects of synergy?
What is the value of expected synergy?
What is the maximum price the acquirer should pay for the target firm?
Financing
Can the proposed purchase price be financed?
What combination of potential sources of funds provides the lowest cost of funds for the acquirer, subject to existing loan covenants?
Deal Structuring
What is the impact on financial performance and valuation if an acquirer is willing to assume certain target liabilities?
What is the impact on the acquirer’s earnings per share of alternative forms of payment?
What are the implications of a purchase of stock versus a purchase of assets?
What is the distribution of ownership of the combined businesses between acquirer and target shareholders following closing?

6. Stock Versus Asset Purchase
Stock purchases:
Statutory or direct merger: Acquirer and Target combine with one disappearing. Target shareholders receive cash or Acquirer stock for their shares. All target assets and liabilities transfer to Acquirer by “rule of law.”
Cash-for-stock or stock-for-stock transactions: Acquirer buys Target stock directly from Target’s shareholders. If unable to buy all Target shares, Target becomes a partially owned Acquirer subsidiary.
Asset Purchases
Cash-for-assets acquisition: Acquirer pays cash for Target’s assets and may assume responsibility for some or all of Target’s liabilities. If enough Target assets have been acquired, the target may be liquidated.
Stock-for-assets transaction, Target shareholders receive Acquirer stock in exchange for the Target’s assets and assumed liabilities. In a second stage, Target dissolves leaving its shareholders with Acquirer stock.

7. M&A Valuation & Structuring Model
M&A Model Overview
Step 1: Construct historical financials and determine key factors (“value drivers) contributing to firm performance
Step 2: Project target’s and acquirer’s financials and estimate their standalone values1
Step 3: Estimate value of combined firms (“Newco”), including synergy and deal terms
Step 4: Determine appropriateness of offer price and Newco’s post-transaction capital structure
M&A Valuation & Structuring Model
(Summary Table)
1A standalone business is one which is not part of another firm and whose cash flows reflect revenue at current market prices and costs include all those required to generate the level of reported revenues.

8. M&A Model Value Drivers
Value drivers are variables which exert the greatest impact on firm value and include the following:
Revenue growth rate
Cost of sales as a percent of sales
S,G,&A as a percent of sales
WACC assumed during annual cash flow growth period (i.e., planning period)
WACC assumed during terminal period
Growth rate assumed during terminal period.

9. M&A Model Worksheet Flow Diagram
Valuation, EPS Impact, & Credit Ratios
Deal Payment Terms
Model Summary:
Deal terms
Form of Payment
Sources/uses of funds
EPS Impact
Projected synergy
Key credit ratios
Valuation estimates
Step 3:
--Estimate synergy
--Create Newco
financials
--Project financials
including synergy
& deal terms
Step 4: Determine appropriateness of offer price and Newco post-transaction capital structure.
Step 1:
--Input Target and
Acquirer
historical
financial
statements
--Determine key
value drivers
Step 2:
-- Input forecast
assumptions to
project Target
and Acquirer
financial
statements
--Estimate
standalone
values
Synergy Data Inputs
Capital Structure Inputs

10. M&A Model Worksheets Model Instructions
Summary (Includes deal terms, sources/uses of funds, synergy estimates, EPS impact, and key credit ratios.)
Step 1: Input historical financial data and determine key value drivers
Target and Acquirer Assumptions (historical data used to project financial statements)
Target and Acquirer Income Statement (historical period only)
Target and Acquirer Balance Sheet Statements (historical period only)
Target and Acquirer Cash Flow Statements (historical periods only)
Step 2: Input Target and Acquirer forecast assumptions and estimate standalone values
Target and Acquirer Assumptions (enables projections of Target and Acquirer financial statements)
Target and Acquirer IS (Income Statement—selected line item s only)
Target and Acquirer BS (Balance Sheet—selected line items only)
Target and Acquirer CF (Cash Flow—selected line items only)
Step 3: Estimate value of Newco, including synergy & deal terms
Newco Assumptions (enables projections of combined firms financial statements)
Newco IS (Income Statement)
Newco BS (Balance Sheet)
Newco CF (Cash Flow)
Step 4: Determine appropriateness of offer price and Newco post-transaction capital structure
Debt Repayment (Includes repayment schedule for target debt assumed by the acquirer, the acquirer’s pre-transaction debt), and new debt issued to finance the deal)
Options-Convertibles (Estimates number of new target shares that must be acquired due to option conversion and the conversion of convertible debt and preferred equity.
Valuation (Includes the valuation of target, acquirer, and Newco enterprise value, equity value and price per share.)

11. Model Balancing Mechanism
Financial models are in balance when total assets (TA) equal liabilities (TL) plus shareholders’ equity (SE).
The model balances automatically:
If TA > TL + SE (i.e., a cash outflow), the firm borrows through its revolving loan facility (credit line) to finance the asset growth
If TA < TL + SE (i.e., a cash inflow), the firm pays off any outstanding revolving loan balance with the cash inflow exceeding the minimum required cash balances

12. Input Versus Formula Model Cells
Cells containing formulas are in black
Cells highlighted in yellow are input cells
Changes to the content of these cells will fill in all cells containing formulas.
When replacing pre-existing data, it is helpful to change the color of those cells for which the data inputs have been made.
Red cells at the bottom of the balance sheet worksheets should be zero indicating the model is in balance.

13. Using the M&A Model
Step 1: Construct historical financial statements for Acquirer and Target and determine key value drivers
Step 2: Project Target and Acquirer financials and determine their standalone value
Step 3: Estimate the value of the combined firms (“Newco), including the effects of synergy & deal terms.
Step 4: Determine the appropriateness of the offer price and Newco’s post-transaction capital structure.

14. Step 1: Construct Historical Financial Statements and Determine Key Value Drivers
Collect/analyze historical financials to identify key value drivers
Normalize/smooth historical data (3-to-5 years if possible) to identify long-term trends
Input actual historical Target and Acquirer data into historical input cells of income statement, balance sheet, and cash flow statement worksheets

15. Target Historical Income Statement
Actual
2013
2014
2015
Sales
$ 3,588.1
$ 3,775.7
$ 3,958.5
Cost of Goods Sold
1,482.0
1,665.7
1,664.1
Gross Profit
2,106.1
2,110.0
2,294.4
SG&A
1,023.2
1,009.0
1,054.6
Other Operating Expense
470.7
453.2
414.6
Depreciation
123.0
123.6
126.0
Amortization
299.6
313.9
302.9
EBIT
189.6
210.3
396.3
Unusual (Gain) Loss
(37.2) -
(Income) from Affiliates
Other Expense (Income)
60.0
10.9
11.9
Interest (Income)
(4.3)
(3.9)
(2.4)
Interest Expense
152.3
162.1
123.9
Earnings before Taxes
18.8
41.2
262.9
Noncontrolling Interest
Taxes
63.7
100.9
101.4
Net Income before Extra Items
(44.9)
(59.7)
161.5
Extraordinary Items
0.6
0.7
0.4
Net Income after Extra Items
$ (44.3)
$ (59.0) $

16. Step 2: Project Acquirer and Target Financials and Estimate Standalone Values
Determine forecast assumptions for each key input variable
Revenue assumption drives cash flow growth
Determine using historical extrapolation or scenario “what if” analysis
Input forecast assumptions into the model and project financials
Select appropriate discount rate and terminal assumptions to estimate standalone values

17. Applying the 5-Forces Model to Project Acquirer and Target Firm Financial Performance
How have the following factors affected revenue growth and profit margins in the acquirer and target firms’ industry historically?
Customers (size, number, price sensitivity)
Current competitors (market share, differentiation)
Potential entrants (entry barriers, relative costs)
Substitutes (availability, prices, switching costs)
Suppliers (size, number, uniqueness)
How will these factors change (if at all) to impact future revenue growth and profit margins of these firms?
Customers (size, number, price sensitivity)
Current competitors (market share, differentiation)
Potential entrants (entry barriers, relative costs)
Substitutes (availability, prices, switching costs)
Suppliers (size, number, uniqueness)
Key questions:
How might changes in the bargaining power of customers and suppliers relative to the acquirer and target firms impact product pricing, costs, and profit margins?
How might substitutes and new entrants affect product pricing and profit margins?

18. Target Assumptions Worksheet
Actual
Projections for the Period Ending December 31,
2013
2014
2015
2016
2017
2018
2019
2020
Income Statement
Sales Growth NA
18.1%
27.7%
27.0%
COGS as a % of Sales
51.3%
52.1%
46.9%
51.2%
SG&A % annual increase (decrease)
16.3%
20.0%
Other Operating Expense as a % of Sales
8.1%
8.4%
8.8%
8.7%
EBITDA Growth
10.8%
90.5%
5.6%
42.8%
40.2%
38.3%
36.8%
EBITDA Margin
10.6%
9.9%
14.8%
12.3%
13.9%
15.3%
16.7%
18.0%
Key Point: Make small changes to assumptions one at a time to assess their
impact on financial statements.

19. Practice Exercise 1
Using the M&A Valuation & Deal Structuring Model accompanying this text:
On the Valuation worksheet, identify the enterprise and equity value of Target and Newco.
On the worksheet named Target Assumptions, increase the sales growth rate by 1% (i.e., to 6.5%). What is the impact on the Target’s and Newco’s enterprise and equity values? (Hint: See Valuation and Summary worksheets)
Click undo command to eliminate increase in sales growth rate or close model but do not save results1 from Practice Exercise 1
Key Point: Impact of assumption changes on value observable on the Valuation and Summary Worksheets
1This allows the model results to revert back to the “base” case and enables the model to be used in additional practice exercises.

20. Practice Exercise 2
Using the M&A Valuation & Deal Structuring Model accompanying this text:
On the Valuation worksheet, identify the enterprise and equity values of Target and Newco?
On the worksheet named Target Assumptions, increase COGS (cost of goods sold) as a percent of sales by one percentage point (i.e., .43 to .44). What is the impact on the Target’s and Newco’s enterprise and equity values? (Hint: See Valuation and Summary worksheets)
Click undo command to eliminate increase in cost of sales or close Model but do not save results from Practice Exercise 2
Key Point: Changes to key driver assumptions should be small and made one at a time to determine their impact on firm value.

21. Step 3: Estimate the Value of Newco, Including Synergy
Estimate synergy and investment required to realize synergy
Project Newco financials including effects of synergy and deal terms
Select appropriate discount rate1 and terminal period assumptions
1The appropriate discount rate for the combined firm’s cash flows should be that associated with the Target if the Target is large relative to the Acquirer and its cash flows are viewed as riskier than those of the Acquirer.

22. Quick Quiz
Which of the following is generally not considered a source of value to the acquiring firm? a. Duplicate facilities b. Patents c. Land on the balance sheet at below market value d. Warranty claims e. Copyrights

23. Summary Worksheet: Deal Terms
Acquirer Transaction Summary
($Millions, except per share data)
Transaction Value
Form of Payment
Sources & Uses
Price Per Share $
% Stock
50.0%
Excess Cash
$ 2,500.0
Target Shares Outstanding
51.3
% Cash
Common Shares Issued to Target Shareholders
3,093.8
Dilutive Effect of Stock Options
2.5
New Common Shares Issued -
Equity Consideration
$ 6,187.7
Target Preannouncement Share Price $
Convertible Preferred Equity
5.00%
Implied Purchase Price Premium
26.2%
Revolving Credit Facility
4.00%
Less: Cash $
Shares %
Senior Debt
4.50%
593.8
Less: Equity in Affiliates
Current Shares Outstanding
475.5
77.3%
Subordinated Debt
10.00%
Plus: Total Debt
9.1
139.4
22.7%
Total Sources
$ 6,187.7
Plus: Noncontrolling Interests
Convertible Preferred Shares
Less Other Adjustments
Convertible Debt
Enterprise Value
$ 5,992.9
New Warrants Issued
Transaction Expenses
5 yrs.
Total Shares
614.9
100.0%
Total Uses

24. Newco Assumptions Worksheet
Actual
Projections
2013
2014
2015
2016
2017
2018
2019
2020
Income Statement
Sales Growth NA
(0.3%)
0.3%
7.7%
3.9%
3.6%
4.0%
4.6%
COGS as a % of Sales
53.3%
53.7%
54.3%
56.1%
54.7%
53.5%
53.4%
Integration Related Expenses ($M)
500.0
250.0
SG&A % annual increase
2.9%
5.8%
5.4%
5.0%
5.1%
5.3%
Other Operating Expense as a % of Sales -
0.6%
0.7%
0.9%
1.1%
1.3%
EBITDA Growth
(10.2%)
(18.6%)
(12.2%)
8.4%
10.1%
(1.5%)
0.1%
EBITDA Margin
14.4%
13.0%
10.6%
8.6%
9.0%
9.6%
9.1%
8.7%
Balance Sheet
Receivable Days
53.3
49.0
54.3
52.2
52.0
51.9
51.7
51.4
Inventory Days
84.6
76.5
71.0
86.9
88.3
89.9
91.8
93.9
Oth Cur Assets % of Sales
2.5%
2.4%
3.0%
2.6%
Days in Accounts Payable
33.4
37.7
45.4
41.8
42.0
42.3
42.7
43.1

25. Summary Worksheet: Newco Synergy Inputs
SG&A Synergies
Gross Margin Improvement
Incremental Sales Synergy
$'s %
Margin
2016
$20.0
0.12%
$25.0
43.9%
100.0
2017
25.0
0.23%
50.0
45.3%
250.0
2018
46.5%
2019
0.22%
46.6%
2020
0.21%

26. Newco Income Statement Worksheet
Actual
Projected 2016
Trans
Pro Forma
Projections
2015
Acquirer
Target
Adj
2016
2017
2018
2019
2020
Sales
$19,062.0
$19,347.9
$1,389.3
$100.0
$20,837.2
$21,652.5
$22,423.4
$23,327.4
$24,399.3
Integration Expenses
500.0
250.0
Cost of Goods Sold
10,354.0
10,447.9
711.3
31.1
11,690.3
11,844.7
11,994.7
12,465.7
13,022.8
Gross Profit
8,708.0
8,900.0
678.0
9,146.9
9,807.8
10,428.8
10,861.7
11,376.4
SG&A
6,693.0
6,960.7
385.7
(10.0)
7,336.4
7,702.0
8,084.1
8,496.3
8,942.8
Other Operating Expense -
120.9
153.5
194.9
247.6
314.4
Depreciation
342.0
309.6
41.7
351.2
367.1
386.1
409.1
437.0
Amortization
85.0
112.0
EBIT
1,588.0
1,629.8
129.7
1,338.4
1,473.2
1,651.6
1,596.7
1,570.2

27. Practice Exercise 3
Using the M&A Valuation & Deal Structuring Model accompanying this text:
On the Valuation worksheet, identify the enterprise and equity values for Newco.
On the Summary worksheet under Incremental Sales Synergy, increase incremental revenue to $200 million in the first year, $250 million in the second year and $350 in the third year. What is the impact on Newco’s enterprise and equity values? (Hint: See Valuation worksheet)
Click undo command to eliminate increases in incremental sales revenue or close model but do not save results from Practice Exercise 3
Key Point: Synergy is generally realized gradually and requires some investment to realize full potential.

28. Step 4: Determine Appropriateness of Offer Price & Post-Transaction Capital Structure
Is the offer price appropriate?:
--Compare offer price with estimated maximum price
and the offer price multiple with recent comparable deals
--Determine if the deal will allow Newco to meet or
exceed required returns (i.e., NPV ≥ 0)1
Is the post-transaction capital structure sustainable?:
--Compare projected Newco credit ratios and industry average
credit ratios
--Determine impact of deal on Newco EPS and current Newco
loan covenants
1NPV = PVNewco (including synergy) – Offer Price (including transaction expenses) ≥ 0

29. Determining the Offer Price
PVMIN = PVT or MVT, whichever is greater. MVT is Target’s current share price times the number of shares outstanding
PVMAX = PVMIN + PVNS, PVNS (net synergy) = PV (sources of value) –
PV (destroyers of value)
PVOP (offer price) = PVMIN + 1 PVNS, where 0    1
Offer price range for Target = (PVT or MVT) < PVOP < (PVT or MVT) + PVNS
Key Point: Offer price lies between the minimum and maximum prices
1Alpha () is that portion of the PV of net synergy paid to Target shareholders.

30. Determining the Offer Price, Premium, and Purchase Price Multiple: An Example
Assumptions:
Target’s pre-deal price per share = $18
Target shares outstanding = 5 million
Target’s current earnings per share = $2.20
Target’s minimum (standalone or market) value = $100 million
PV of net synergy = $20 million
Alpha () = 50%
Offer Price, Premium, and Purchase Price Multiple:
Offer price per share = (Target’s minimum value +  x PVnetsynergy) /
Target shares outstanding
= ($100 million + .5 x $20 million) / 5 million = $22
Offer (purchase) price premium = $22/$18 = 22.2%
Offer (purchase) price multiple = $22 / $2.20 = 101
1Offer price multiple, in this instance measured as a P/E ratio, can be compared to P/E ratios for recent comparable transactions to determine the reasonableness of the premium.

31. Accretion / (Dilution)
Summary Worksheet (Performance Metrics): Newco EPS, Valuation & Key Credit Ratios
Earnings per Share
Acquirer
Newco
Cash EPS
Accretion / (Dilution)
EPS
2016P $ $ $ $
2005P
(42.5%)
112.9%
2017P $ $ $ $
(20.2%)
(21.2%)
2018P $ $ $ $
1.2%
(4.8%)
2019P $ $ $ $
13.6%
8.9%
2020P $ $ $ $
34.5%
23.1%
Valuation
Present Value $'s
Newco Total Debt to Total Capital 
Newco Interest Coverage (EBITDA to Interest Expense)
Target
$ 5,590.7
5.7%
44.6x
36,330.3
5.0%
56.5x
48,110.8
4.2%
68.9x
Synergies
6,189.8
3.6%
76.0x
Newco Terminal Value/Enterprise Value
77.0%
3.0%
86.4x

32. Summary Worksheet: Deal Financing
Acquirer Transaction Summary
($Millions, except per share data)
Transaction Value
Form of Payment
Sources & Uses
Price Per Share $
% Stock
50.0%
Excess Cash
$ 2,500.0
Target Shares Outstanding
51.3
% Cash
Common Shares Issued to Target Shareholders
3,093.8
Dilutive Effect of Stock Options
2.5
New Common Shares Issued -
Equity Consideration
$ 6,187.7
Target Preannouncement Share Price $
Convertible Preferred Equity
5.00%
Implied Purchase Price Premium
26.2%
Revolving Credit Facility
4.00%
Less: Cash $
Shares %
Term Debt
4.50%
593.8
Less: Equity in Affiliates
Current Shares Outstanding
475.5
77.3%
Subordinated Debt
10.00%
Plus: Total Debt
9.1
139.4
22.7%
Total Sources
$ 6,187.7
Plus: Noncontrolling Interests
Convertible Preferred Shares
Less Other Adjustments
Convertible Debt
Enterprise Value
$ 5,992.9
New Warrants Issued
Transaction Expenses
5 yrs.
Total Shares
614.9
100.0%
Total Uses

33. Newco Balance Sheet Worksheet
Actual 2015
Pre-Trans
Trans
Pro Forma
Projections
Acquirer
Target
Adj
2015
2016
2017
Cash
$ 4,938.0 $
$ (2,500.0)
$ 2,641.9
$ 5,236.2
$ 5,704.6
Accounts Receivable
2,838.0
102.0
2,940.0
2,979.5
3,087.7
Inventory
2,015.0
215.4 -
2,230.4
138.6
138.4
Other
563.0
19.3
582.3
533.4
552.3
Current Assets
10,354.0
540.6
8,394.6
8,887.7
9,482.9
Property, Plant, & Equipment
4,906.0
162.9
5,068.9
5,504.4
5,953.8
Accumulated Depreciation
(2,791.0)
(86.8)
(2,877.8)
(3,229.0)
(3,596.2)
Net Property, Plant, & Equipment
2,115.0
76.1
2,191.1
2,275.3
2,357.6
Goodwill
205.0
5,690.7
5,895.7
5,883.7
5,871.7
Intangible Assets
487.0
3.9
490.9
390.9
290.9
Deferred Taxes
1,184.0
36.6
1,220.6
1,275.6
1,330.6
53.0
18.2
71.2
Total Assets
$ 14,398.0 $
$ 18,264.1
$ 18,784.4
$ 19,404.9
Accounts Payable
1,289.0
84.7
1,373.7
1,339.2
1,364.5
2,069.0
64.4
2,133.4
2,279.2
2,295.5
Current Liabilities
3,358.0
149.1
3,507.1
3,618.4
3,660.0
Senior Debt
276.0
9.1
593.8
878.9
804.7
730.5
Subordinated Debt
Total
910.0
944.0
978.0
11.0
20.2
31.2
Total Liabilities
4,555.0
178.4
5,327.2
5,398.3
5,399.7
Common Stock
3,947.0
225.0
2,868.8
7,040.8
Retained Earnings
5,801.0
270.0
(270.0)
6,250.2
6,869.4
Other Adjustments
95.0
2.0
(2.0)
Total Stockholders Equity
9,843.0
497.0
12,936.8 #
13,386.1
14,005.2
Total Liabilities and Equity

34. Practice Exercise 4
Using the M&A Valuation & Deal Structuring Model accompanying this text:
On the Summary worksheet under the Sources and Uses heading, note how the purchase price is financed.
Under the heading Form of Payment, change the composition of the purchase price to 100% cash. Assume the purchase price is partially financed by reducing Acquirer excess cash by $1 billion and by raising $4 billion by issuing new Acquirer equity to the public. Under the Sources and Uses heading, how is the remainder of the purchase price financed?
Change the composition of the purchase price to 100% equity, what is the impact on how the purchase price is financed?
Click undo command to eliminate changes to base case model or close model but do not save the results from Practice Exercise 4
Key Point: How a deal is financed reflects: form of payment (share exchange requires new Acquirer shares), that combination of sources of funds resulting in the lowest average cost of funds, and the impact on Newco EPS and current loan covenants,

35. Practice Exercise 5
Using the M&A Deal Structuring Model accompanying this text:
On the Summary worksheet under the Valuation heading (lower left hand corner of worksheet), note the net present value of Newco including synergy (last row of worksheet).
On the Valuation worksheet, increase Newco’s terminal value growth rate by one percentage point and reduce the discount rate by one percentage point (lower left hand corner) and enter the new values. How do these changes in the Newco terminal value assumptions affect Newco’s net present value including synergy on the Summary worksheet?
Click undo command to eliminate changes to the base case model or close model but do not save the results from Practice Exercise 5
Key Point: Small changes in terminal value assumptions result in disproportionately large changes in firm value.

36. Calculating Offer Price Per Share and Target’s Equity Value Under Alternative Payment Scenarios
All Stock Transaction:
Offer Price Per Share = Share Exchange Ratio1 x Acquirer’s Share Price
= Offer Price Per Share x Acquirer’s Share Price
Acquirer’s Share Price
Equity Value = Offer Price Per Share x Target’s Fully Diluted Shares Outstanding2
All Cash Transaction:
Offer Price Per Share = Cash Offer Per Target Share
Equity Value = Cash Offer Per Target Share x Target’s Fully Diluted Shares
Outstanding
Cash and Stock Transaction:
Offer Price Per Share = Cash Offer Per Share + (Share Exchange Ratio x Acquirer’s
Share Price)
Equity Value = [Cash Offer Per Share + (Share Exchange Ratio x Acquirer’s Share
Price)] x Target’s Fully Diluted Shares Outstanding
1When share exchange ratios (SERs) are fixed, the value of the transaction can change due to fluctuations in the acquirer’s share price. Assume the SER is 2 and the acquirer’s share price is $50, the offer price per share is $100. However, if the acquirer’s share price falls to $40 or increases to $60 before closing, the offer price is $80 and $120, respectively. Under a floating SER, the dollar value of the offer price per share is fixed and the number of shares exchanged varies with the value of the acquirer’s share price. Acquirer share price changes require re-estimating the SER. For example, if the acquirer’s share price falls to $40, the number of new acquirer shares issued per target share to preserve the $100 offer price is 2.5 (i.e., $100/$40); if the acquirer’s share price rises to $60, the new SER would be (i.e., $100/$60). Fixed SERS are most common because the risk of changes in the offer price is shared equally by the acquirer (i.e., if acquirer’s share price rises) and the target (i.e., if the acquirer’s share price falls).
2Fully diluted shares represent the total number of Target shares outstanding if all options, convertible preferred and debt outstanding were converted into Target common shares.

37. Calculating Post-Merger EPS in a Cash & Stock Transaction: Practice Exercise 6
Assume the offer or purchase price determined through negotiation is $84.30 for each Target share and consists of 1 share of Acquirer stock (i.e., $56.25) and $28.05 (i.e., $84.30 offer price - $56.25) in cash. Furthermore, assume that the cash portion of the purchase price is financed by the acquirer at an 8% annual interest rate with the principal due in 10 years. The firm’s marginal tax rate is 40%. What is the earnings per share of the combined businesses after closing?
Pre-Merger Data
Acquirer
Target
Net Earnings
$281,500,000
$62,500,000
Shares Outstanding
112,000,000
18,750,000
EPS
$2.51
$3.33
Market Price Per Share
$56.25
$62.50

38. Assumptions about Target
Calculating the Target’s Fully Diluted Shares Outstanding and Adjusting Equity Value (If Converted Method)
Assumptions about Target
Comment
Basic Shares Outstanding
2,000,000
In-the-Money Optionsa
150,000
Exercise Price = $15/share
Convertible Debentures (Face value = $1000; convertible into 50 shares of common stock; implied conversion price = $20 (i.e. $1000/50))
Preferred Stock (Par value = $60; convertible into 3 common shares; implied conversion price = $20 (i.e., $60/3))
$10,000,000
$5,000,000
Number of Debentures outstanding = $10,000,000/$1,000 = 10,000
If fully converted = 10,000 x 50 =
500,000 common shares
Preferred shares outstanding = $5,000,000 / $60 = 83,333
If fully converted = 83,333 x 3 =250,000 common shares
Offer Price Per Share
$30
Purchase price offered for each target share outstanding
Total Shares Outstandingb = 2,000, , , ,000
= 2,900,000
Adjusted Target Equity Valuec = 2,900,000 x $ ,000 x $15
= $87,000,000 - $2,250,000
= $84,750,000
aAn option whose exercise price is below the market value of the firm’s share price.
cTotal shares Outstanding = Issued Shares + Shares from “in the money” options and convertible securities.
dPurchase price adjusted for new acquirer shares issued for convertible shares or debt less cash received from “in the money” option holders.
Key Point: Actual purchase price is $84.8 million rather than $60 million.

39. Calculating Fully Diluted Shares Outstanding: Options
Options Outstanding (Mil. of Shares)
Strike Price
In the Money
Number Likely to be Converted
4.045
$37.46
Yes
Assumptions:
Current Target Share Price = Offer Price = $82/share
Proceeds from Option Holders used to repurchase Target shares at current Target share price
New Target Shares from Option Conversion:
What firm has to pay to repurchase new Target shares: $82 x = $331.69
What firm receives from converting option holders: $37.46 x = $151.53
Difference = $180.16
New Target shares issued = [Cost to Repurchase All Shares Converted – Proceeds from Converting Option Holders] / Current Target Share Price = $ / $82 =
Key Point: Add new shares issued to Target’s basic shares outstanding

40. Calculating Fully Diluted Shares Outstanding: Convertible Debt
Principal (Millions)
Par Value
Conversion Ratio
Conversion Price
Likely to Convert
New Shares
$.44
$1000 20
$50
Yes
.0088
Assumptions:
Current Target share price = offer price = $82/share
New Target Shares Issued:
Conversion Ratio (CV) = Number of target common shares when debt converted at par value = 20
CV Price = Par Value / CV Ratio = $1000/20 = $50
New Target Shares = ($.44 / $1000) x 20 = (i.e., 88,000 shares)
Key Point: Add new shares issued to Target’s basic shares outstanding.

41. Calculating Fully Diluted Shares Outstanding: Convertible Preferred
Balance
Par Value
CV Ratio
CV Price
Likely to Convert
New Shares
$3.40
$100
1.7
$57.14
Yes
.0595
Assumptions:
Current Target share price = offer price = $82/share
New Shares Issued:
Conversion Ratio (CV) = number of new Target shares when converted at par value = 1.75
CV Price = $100 / 1.75 = $57.14
New Target Shares Issues = )$3.40 / $100) x 1.75 = (i.e., 59,500 shares)
Key Point: Add new shares issued to Target’s basic shares outstanding

42. Modeling An Asset Purchase
As with a stock purchase model, asset purchases begin with the estimation of Target’s enterprise value.1
Enterprise value is then adjusted by subtracting Target assets excluded from the deal (Aexcl) and Target liabilities included in the deal (Linc). The end result is referred to as net acquired assets.
Net Acquired Assets = TA – Aexcl – Linc = Aincl – Linc
where Aincl equals Target assets included in the deal.
The purchase price is what Acquirer pays for net acquired assets and is often expressed as a multiple of net book assets (i.e., book assets less book liabilities).
1Recall that enterprise value can be viewed from either the asset side (total assets) or the liability side (total liabilities plus equity) of the balance sheet. In the context of an asset purchase, enterprise value equals total Target assets. TA = Aexcl + Aincl = Lexcl + Lincl + EQ and Aincl – Lincl = Lexcl – Aexcl + EQ, where EQ = Target shareholders’ equity and Ainc – Lincl = Net acquired assets by Acquirer.

43. Asset Purchase Illustration
Assume that Acquirer pays $90 million to purchase $75 million in net acquired assets, consisting of $100 million of Target net property, plant and equipment (i.e., Net PP&E) less assumed Target current liabilities of $25 million and that the book values of Target assets and liabilities are equal to their fair market value.
The purchase is financed by using $20 million in Acquirer pre-transaction cash balances and by borrowing $70 million in long-term debt.
Synergies in the first year include a reduction in cost of sales of $5 million. First year integration expenses are $15 million.
The implied purchase price multiple is 1.2 times net acquired assets (i.e., $90 million/$75 million).

44. Asset Purchase: Acquirer Income Statement Adjustments

45. Asset Purchase: Acquirer Balance Sheet Adjustments
Table 9.12 Acquirer Balance Sheet: Asset Purchase
Actual
Trans
Pro Forma
2015
Adj.
2016
Acquirer Pre-Deal
Acquirer Post-Deal
Cash
$125.00
($20.00)
$105.00
Current Assets (Excl. Cash)
550.00
Net Property, Plant & Equipment
1,250.00
100.00
1,350.00
Goodwill
15.00
Other Long-Term Assets
450.00
Total Assets
$2,375.00
$2,470.00
Current Liabilities
25.00
575.00
Long-Term Debt
70.00
520.00
Other Long-Term Liabilities
375.00
Total Liabilities
1,375.00
1,470.00
Common Stock
500.00
Preferred Equity
50.00
Retained Earnings
400.00
Other Adjustments
Total Shareholders‘
Equity
1,000.00
Total Liabilities and

46. Asset Purchase: Acquirer Cash Flow Statement Adjustments
2015 Ending Cash
$125.00
Cash used to finance PP&E Purchase
(20.00)
2016 Beginning Cash Balance
$105.00
Cash from Operations
Net Income
(1.20)
Depreciation
0.00
(Gain)/Loss
(10.00)
Current Assets
Current Liabilities
25.00
Net cash flow from Operations
13.80
Cash from Investing
PP&E Acquisition
(90.00)
Net cash flow from Investing
Cash from Financing
Increase in Debt
70.00
Net Cash Flow from Financing
Net Cash Flow
(6.20)
Ending Cash Balance
$98.80

47. Things to Remember…
Financial modeling facilitates the process of valuation, deal structuring, and selection of the appropriate financing plan.
The process entails the following four steps:
Step 1: Construct historical financial statements for Acquirer and Target and determine key value drivers
Step 2: Project Target and Acquirer financials and determine their standalone value
Step 3: Estimate the value of the combined firms (“Newco), including the effects of synergy & deal terms.
Step 4: Determine the appropriateness of the offer price and Newco’s post-transaction capital structure.