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

(Hop HipldF0AV) #1

Notwithstandingthisprinciple,therearesomecommonerrors
that continue to be made when it comes to valuing synergy:



  • Cash flows generated by synergy accrue to the
    combinedfirmandnottothetargetoracquiringfirm
    separately.Weshouldbeusingthecombinedfirm’s
    cost ofequityand/orcapitaltodiscountthesecash
    flows. In many acquisitions, the cash flows from
    synergyarediscountedateithertheacquiringfirm’s
    or the target firm’s cost of equity/capital.

  • As we noted earlier, analysts often discount tax
    savingsthatariseasaconsequenceofacquisitionsat
    therisklessrate.Cashflowsgeneratedbysynergyare
    neverriskless,andusingtherisklessratetodiscount
    cash flows is inappropriate.

  • Ifthesynergyinvolvesenteringnewbusinesseswith
    verydifferentriskcharacteristicsthanthoseinwhich
    eithertheacquiringfirmorthetargetfirmisinvolved
    atthetimeofthemerger,thediscountrateusedfor
    the cash flows should be different from both the
    acquiring firm’s and target firm’s costs of capital.


Mixing Control and Synergy


Whilesynergyisusedasareasonformanymergers,theother
oft-stated rationale in acquisitions is control.The value of
controlderivesfromchangingthewayacompanyisrunand
willbehigheratpoorlymanaged,poorlyrunfirms.Inmany
acquisitionvaluations,thevalueofcontrolandsynergyare
assessedtogetheranditisdifficulttodeterminewhereone
endsandtheotherbegins.Bycombiningthetwo,wealsorun
the risk of using the wrong discount rates to value each
component.Thevalueofcontrolis verydifferentfrom the

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