M＆A（Mergers and Acquisitions)

The value of a company is determined by its NPV

The value of a company at the time of a merger or acquisition is not calculated based on the book value for accounting purposes, but based on the concept of finance. In other words, the current enterprise value/business value is the present value of the FCF (free cash flow) that the target enterprise (business) will generate in the future. This can be explained by the fact that for the acquiring company it is nothing other than the Net Present Value (NPV) of the investment. The calculation of enterprise value is therefore based on discounting the free cash flows to be generated in a given future period by the weighted average cost of capital.

What is the Weighted Average Cost of Capital (WACC)?

The Weighted Average Cost Of Capital (WACC) is a weighted average of the capital that a company raises to develop its business, which can be classified as other people’s capital or equity capital, and because they have different orders of return and different degrees of risk, the weighted average of both Since WACC refers to the yield demanded by investors not only during M&A but also in normal times, an NPV > 0 is also an effective indicator of sound management, and by discounting free cash flows by WACC, the value of individual companies is calculated and the transfer price is derived. The transfer price is derived by discounting the free cash flow by the WACC.

Valuation

As the company value is determined by the NPV, the calculation of the share price is not based solely on tax law or book value, but is also determined by finance. In practice, valuations are generally carried out using multiple methods rather than NPV alone.

M&A document ‘Compendium of successful mergers and acquisitions’