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