Damodaran on Valuation_ Security Analysis for Investment and Corporate Finance ( PDFDrive )

words,thereistruthtotheadagethatyoucanfoolsomeof
the investors some of the time.

Quick Growth

Facedwiththeprospectsofanemicgrowthinternally,many
firms look for ways to increase growth quickly. Internal
investments may be prudent, but they often have long
gestationperiods andwaitingforgrowthtoshowupisnot
consideredanoption.Itisnotsurprisingthatthesefirmsare
oftenthemostaggressiveacquirersandtheirprimarytargets
are usually companies with significant growth prospects.
Though thebenefits of higher growth are undeniable, the
price paid for that growth determines whether such
acquisitions make sense. If the price paid for the growth
exceedsthefairmarketvalue,thestockpriceoftheacquiring
firmwilldeclineeventhoughtheexpectedfuturegrowthin
its cash flows may increase as a consequence of the takeover.

This can be seen with a simple example. Assumethat an
acquiring firm with minimal growth prospects acquires a
targetfirmwithlucrativeinvestmentopportunitiesandhigh
growthpotential.Table15.4summarizesthecharacteristicsof
the two companies.

TABLE 15.4Acquiring and Target Firms: Growth Merger

Acquiring

Firm

Target

Firm

Beta 0.8 1.2

Pretax cost of debt 5% 5%

Tax rate 30% 30%