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Chapter 13: CORPORATE VALUATION (C) Cost approach

The cost approach, which is also known as the

asset-based approach, is able to extract value
Corporate valuation is the process of by combining the FMV (Fair Market Value) of
determining the value of a company entity, the company's net assets.
and it is most commonly used in the context of
the financial industry. Primary methods that can be utilized for
determining the value of a firm are
There are two primary types of value, which
are as follows: 1. Adjusted Book Value Approach,

(a) Book Value 2. Stock and Debt Approach,

The value of an asset or the complete business 3. Direct Comparison Approach, and
entity as established by the books or the 4. Discounted Cash Flow Approach.
financials of the company.
ADJUSTED BOOK VALUE APPROACH:
(b) Market Value
When determining the value of a company,
This refers to the value that is derived through there are two methods
the analysis of the market.
1. Direct tally of the book values of investor
APPROACHES TO CORPORATE VALUATION: claims might be performed, if desired.
The principal valuation approaches, as per IVS 2. The total value of the company's assets can
105, are: be determined, and then from that figure, any
(a) Market approach claims made by parties other than investors
(such as accounts payable and provisions) can
A valuation method that determines the value be subtracted.
of a company, an intangible asset, an
ownership stake in a firm, or of securities, by The following methodology may be used to
taking into account the price of a recent assign values to each of the assets:
transaction or the price of assets that are Cash and Cash Equivalents:
comparable to the one being valued.
The value of money does not change under any
(b) Income approach circumstances.
When valuing a company, the income Receivables:
approach is utilized to determine the present
The value of receivables is determined by their
or current value of the company's expected
face value.
future earnings or cash flows.
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Stocks in hand: DISCOUNTED CASH FLOW APPROACH:

Raw materials, work-in-process, and finished The discount rate is determined by that
goods company's cost of capital. The total Present
Value (PV) of all future cash flows can be
Other Current Assets:
calculated by multiplying this discount by each
Deposits, prepaid expenses, and accruals. future cash flow to arrive at a number that
represents the total present value of all future
Tangible Fixed Assets:
cash flows.
Land, buildings and other civil works, as well as
To calculate Present Value (PV) of a firm, we
machinery and plant.
use the following formula:
Intangible Fixed Assets: 𝑪𝒕
PV=∑𝒏𝒕=𝟏 (𝟏+𝒓)𝒕
Patents, software, copyrights, mining leases,
licenses, spectrum (used for STEPS INVOLVED IN VALUATION USING DCF
telecommunication). APPROACH:

Non-operating Assets: Step 1. Analyze historical performance to

calculate:
The assets that are not essential to its day-to-
day operations. a) Operating Invested Capital

FOR EX. Financial securities, surplus land. b) Net operating profit less adjusted taxes

STOCK AND DEBT APPROACH: c) Return on Invested Capital

When a company's securities are traded on a d) Net Investments

public exchange, the worth of the company can
STEP 2: CALCULATING THE FREE CASH FLOW
be determined by simply adding the current
market value of all of its outstanding securities. The Free Cash Flow (FCF) can be calculated as
follows:
DIRECT COMPARISON APPROACH:
FCF NOPLAT - Net investment
A buyer will not pay more for a given property
than the cost of a comparable, competitive FCF (NOPLAT + Depreciation) - (Net investment
property with the same utility in the open + Depreciation)
market, provided there is no delay in making
FCF Gross cash flow Gross investment
the transaction
STEP 3: ESTIMATING THE COST OF CAPITAL

The cost of capital is calculated by taking the

average of the costs of each source and then
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weighting that average by the percentage of ii)Value driver method
total capital that each source represent. It is
2) Non-Cash Flow Methods:
also known as the weighted cost of capital
(WCC) or the weighted average cost of capital i) Replacement Cost Method
(WACC).
ii) Price-PBIT ratio method
The weighted average cost of capital shall be
iii) Market-to-book ratio method
calculated using the following formula:
Both the cash flow methods assume that after
WACC = wdrd + wprp +were
explicit forecast period, the cash flows will
STEP 4: FORECASTING PERFORMANCE grow at a constant rate forever.

The following are the steps involved in this. Formula will be:

a) Choose the explicit time period for the PVT FCFt+1+/ (WACC - g)
forecast.
Where,
b) In order to improve the company's
PVT is the terminal or continuing value of the
performance in the future, you should develop
enterprise,
a strategic vision.
FCFt+1is the free cash flow during the first year
c) Translate the strategic vision into financial
after the explicit forecast period T,
forecasts.
WACC is the weighted average cost of capital
d) Check that everything is aligned and
and,
consistent.
G is the constant growth rate after the explicit
STEP 5: DETERMINING THE TERMINAL OR
forecast period
CONTINUING VALUE
b) Computation of the continuing value:
The estimation of the continuing value is
accomplished in two stages: The weighted average cost of capital (also
known as WACC) and a constant growth rate
a) Selection of a suitable method:
(G) are two essential components that must be
Prof. Prasanna Chandra in his book 'Financial specified for finding the continuing value using
Management- Theory & Practice'. Mc Graw Hill this approach.
India (10th Edition) has given the following
STEP 6. CALCULATING THE FIRM VALUE AND
methods:
INTERPRETING THE RESULTS
1) Cash Flow Methods:
The following components can be added
i) Growing free cash flow perpetuity method together to arrive at an estimate of the
company's value:
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(a) The value, in present terms, of the free cash Estimating future Growth:
flow over the time covered by the explicit
There are three different methods that can be
forecast
used to estimate growth.
(b) Continued Value after the explicit forecast
1. Investigate the past of a company and
period, arrived as per details in the previous
employ the historical growth rate that was
paragraph, discounted to its present value.
reported by that company.
(c) The value of non-operating assets not taken
2. Estimates of growth from sources that have
into account when the free flow analysis was
a greater level of expertise.
carried out.
3. Conduct a survey.

Estimating Growth Patterns:

Chapter-14: Discounted Cash Flow
When valuing a company in general, there are
Valuation
three main approaches that may be taken, for
the growth pattern:

Expected Cash Flows: (a) We can assume that the company is

already in stable growth;
Estimating the cash flows prior to payments
on debt and preferred dividends take the (b) We can assume a time of consistent high
after-tax operating income and remove the growth and subsequently lower the growth
net investment that is required to maintain rate to stable growth (two-stage growth); or,
growth which gives estimate of the cash flows. (c) We can provide for an interim period to get
The models that make use of these cash flows to sustained growth (three-stage or n-stage
are referred to as FCFF models, and this cash models).
flow is referred to as the free cash flow to the
firm (FCFF).

Discount Rates:-

Present value of future cash flows by using a

rate that is the cost of capital that most
accurately reflects the risk and timing of the
cash flows. This rate is called the discount
rate.
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APPROACHES TO DISCOUNTED CASH FLOW MODELS:

APPROACH I
Free Cash Flow

Type of
Static to Equity
Yes
Is it possible Leverage
to estimate Free Cash
Cash Flows? Dynami
Use Dividend Flow to Firm
No Discount Model c

APPROACH II

Positive Use Current

& Normal Earning Base Use Normalised
Earning in place
of Current
Current Earnings
Earning Yes
Margin
Abnorma Current Adjustment
Survival is Yes
l Earning Needed
Possible? Value Equity
Negative
No as an option
Yes to Liquidate
Firm
No
Overburdened
with Debt
Estimate
No Liquidation
Value

APPROACH III

If less than Use Stable

Economy’s Growth Model
Growth Rate
Use Two Stage
Present Yes
Model
Growth Rate

If less than Is Competitive

Economy’s Advantage Short
Growth Rate Lived?
𝐔𝐬𝐞 𝐓𝐡𝐞𝐫𝐞 𝐒𝐭𝐚𝐠𝐞
No 𝐧 − 𝐬𝐭𝐚𝐠𝐞 𝐌𝐨𝐝𝐞𝐥
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VARIOUS DISCOUNTED CASH FLOW MODELS: According to this hypothesis, the value of a
share is computed as follows:
There are several Discounted Cash Flow
Models which are widely used: 𝐃𝟏 𝐃𝟏 (𝟏 + 𝐠) 𝐃𝟏 (𝟏 + 𝐠)𝐧
𝐏𝟎 = + + ⋯
(𝟏 + 𝐫) (𝟏 + 𝐫)𝟐 (𝟏 + 𝐫)𝐧+𝟏
Enterprise DCF Model:
+⋯
The enterprise DCF model applies a discount
Where,
rate equal to the weighted average cost of
capital to the free cash flow to the firm (FCFF). 𝐏𝟎 Is the current fair price of the share?

Equity DCF Model: D₁ is the expected dividend one year from now

The equity discounted cash flow model can be R is the rate of return required by the investor
implemented in two different ways: the N represents any particular year and can be
dividend discount model and the free cash any number between 0 and infinity
flow to equity model.
Following the use of the formula for the sum
Adjusted Present Value (APV) Model: of a geometric progression, the preceding
The APV model discounts the unlevered equity expression can be simplified to:
cash flow (which is the same as the free cash 𝐃𝟏
flow to the firm) at the unlevered cost of 𝐏𝟎
(𝐫 − 𝐠)
equity (the cost of equity assuming the firm
has no leverage) and adds to it the discounted
value of the interest tax shield on debt. Illustration:
The Economic Profit Model: XYZ Ltd. is expected to pay a dividend of Rs. 3
Economic profit stream is discounted using the per share one year from now.
weighted average cost of capital, and then the The dividend payments are expected to grow
currently invested capital is added to the at 5% p.a. If an investor needs 12% rate of
resulting value. return on his investment, what price of the
DIVIDEND DISCOUNT MODEL: share will be considered to be fair, by him?

The various dividend discount models used for Solution:

valuation are as under: Applying the formula, given above,
Constant Growth Model: 𝐃𝟏
𝐏𝟎
(𝐫 − 𝐠)
The dividend paid out per share would
increase at a rate that is fixed (g). 𝟑 𝟑
We get 𝐏𝟎 = (𝟎.𝟏𝟐−𝟎.𝟎𝟓) = 𝟎.𝟎𝟕 = Rs. 42.86
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The vast majority of stock valuation models where 𝐏𝟎 is the present price of the equity
are founded on the idea that dividends will share, D, is the dividend that is anticipated to
increase over the course of time. be paid out one year from now, g₁ is the
extraordinary growth rate that is valid for n
Zero Growth Model:
years, and P is the price of the equity share at
In the event that we make the assumption the end of year n.
that the dividend per share stays the same
Illustration:
from year to year at a value of D, the formula
will look like this: The current dividend on an equity share of
PML Private Limited is Rs. 5.
𝐏𝟎 = D/r
PML is expected to enjoy an above-normal
Illustration:
growth rate of 25% for a period of 6 years.
XYZ Ltd. is expected to pay a dividend of Rs. 3
Thereafter, the growth rate will fall and
per share one year from now.
stabilize at 15%. Equity investors require a
The dividend payments are expected to return of 20%.
remain constant at Rs. 3 per share.
What is the intrinsic value of the equity share
If an investor needs 12% rate of return on his of PML?
investment, what price of the share will be
The inputs required for applying the two-stage
considered to be fair, by him?
model are:
Solution:
g₁ = 25%
Applying the formula for fair value,
𝐠 𝟐 = 15%
𝐃𝟏
𝐏𝟎 n = 6 years
(𝐫 − 𝐠)
𝟑 𝟑 r = 20%
We get 𝐏𝟎 = (𝟎.𝟏𝟐−𝟎.𝟎𝟓) = 𝟎.𝟏𝟐 = Rs. 25.00 0
D₁ = D₁ (1+g₁) = Rs. 5(1.25) = Rs. 6.25

Plugging these inputs in the two-stage model,

Two Stage Model: we get the intrinsic value estimate as follows:
In the event where the dividends increase at a 𝐏 𝟏−(𝟏.𝟐𝟓/𝟏.𝟐𝟎)𝟔 𝟔.𝟐𝟓(𝟏.𝟐𝟓)𝟓 (𝟏.𝟏𝟓)
𝟎 = 𝟔.𝟐𝟓 (𝟎.𝟐𝟎−𝟎.𝟐𝟓) + (𝟏⁄𝟏.𝟐𝟎)𝟔
rate that is proportional to the rate of growth, (𝟎.𝟐𝟎−𝟎.𝟏𝟓)

the market price of the equity share will be: (𝟏−𝟏.𝟐𝟕𝟖) 𝟔.𝟐𝟓(𝟑.𝟎𝟓𝟐)(𝟏.𝟏𝟓)
𝑷𝟎 = 6.25 + (𝟎. 𝟑𝟑𝟒)
−𝟎.𝟎𝟓 𝟎.𝟎𝟓
𝐃 𝐃𝟏(𝟏+𝐠 ) 𝐃𝟏(𝟏+𝐠 )𝟐 𝐃𝟏(𝟏+𝐠 )𝐧−𝟏
𝟏 𝟏 𝟏 𝟏
𝐏𝟎 =(𝟏+𝐫) + + ….+ + = 34.6918 + 146.9165
(𝟏+𝐫)𝟐 (𝟏+𝐫)𝟑 (𝟏+𝐫)𝐧
𝐏𝐧
⋯ (𝟏+𝐫) = Rs. 181.6083
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H Model: 𝐠 𝐧 = 10%

The H model, which was developed by Fuller r = 15%

and Hsia, makes the assumption that the
Putting the above inputs in the H-model, we
earnings growth rate starts off at a high initial
get the estimated intrinsic value as follows:
rate (𝐠 𝐚 ), and then decreases at a linear rate
over the course of 2H years to a stable growth
rate (𝐠 𝐧 ), which is maintained forever. 𝟏[(𝟏.𝟏𝟎)+(𝟎.𝟑𝟎−𝟎.𝟏𝟎)]
𝐏𝟎 = = Rs. 42.00
𝟎.𝟏𝟓−𝟎.𝟏𝟎
The equation for H model of valuation is as
under: APPLICABILITY OF THE DIVIDEND DISCOUNT
MODEL:
𝐏𝟎 = 𝐃𝐨[(𝟏 + 𝐠 𝐧 ) + 𝐇 (𝐠 𝐚 − 𝐠 𝐧 )]
𝐫 − 𝐠𝐧 This model, however, offers certain
advantages as follows:
where r is the rate of return needed by
investors, 𝐏𝟎 is the intrinsic value of each a) It is easy to understand and has a natural
share, 𝐃𝟎 is the current dividend per share, 𝐠 𝐧 appeal.
is the expected long-term growth rate, 𝐠 𝐚 is
b) The forecasting of dividends requires a
the current growth rate, and H is the one half
smaller number of assumptions than the
of duration during which 𝐠 𝐚 levels out to 𝐠 𝐧.
forecasting of free cash flows.
ILLUSTRATION:
c) A smoothed dividend policy is typically
The equity shares of ABC Private Limited implemented by companies.
presently generate a dividend payment of
Rupee 1.00 every year.

The growth rate as of right now is 30%. Chapter-15: Other NON- DCF
VALUATION MODELS
On the other hand, this will decrease in a
linear fashion over the course of ten years,
and then it will level off at ten percent.
RELATIVE VALUATION MODEL:
What is the company's intrinsic worth per
A relative valuation places an asset's worth in
share, assuming that investors require a return
comparison to the prices at which other,
of 15% on their investment? The following
comparable assets are selling on the market,
information is available:
at the moment.
𝐃𝟎 = 1.00
Steps Involved in Relative Valuation:
𝐠 𝐚 = 30%
Relative valuation involves the following
H = 5 years steps:
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Conducting Research on the Concerned (a) Stock valuation multiples, such as the
Organization: price-earnings ratio, the price-book value
ratio, and the price sales ratio, and
➢ The following will be discussed in this
analysis: (b) Enterprise valuation multiples (EV-EBITDA
ratio, EV-FCFF ratio, EV-book value ratio, and
➢ The company's product catalogue and the
EV-sales ratio).
many market sectors that it serves
Establishing a Value for the Concerned
➢ The availability of inputs and the prices of
Business:
those inputs
The growth prospects, risk characteristics, and
➢ Technological potential as well as
size of the subject company (the most
manufacturing capacity
important drivers of valuation multiples)
➢ Reputation in the market, availability of should be compared with those of comparable
distribution, and continued patronage companies, and after that, a judgmental view
of the multiples that are applicable to it
➢ Differences in the products themselves, as
should be taken.
well as their economic and competitive
positions EQUITY VALUATION MULTIPLES
➢ Capability and motivation on the part of the MODEL:
manager
P/E Multiple:
➢ The competence and caliber of the
The price-to-earnings multiple, or P/E
available human resources
multiple, is a popular valuation statistic that is
Identifying Businesses That Are Analogous: typically defined as follows:
𝐌𝐚𝐫𝐤𝐞𝐭 𝐩𝐫𝐢𝐜𝐞 𝐩𝐞𝐫 𝐬𝐡𝐚𝐫𝐞
Following the analysis of the subject firm, the P/E multiple = 𝐄𝐚𝐫𝐧𝐢𝐧𝐠𝐬 𝐩𝐞𝐫 𝐬𝐡𝐚𝐫𝐞
next stage is to choose other businesses that
are comparable to the original company in Fundamental Determinants of the P/E
terms of the types of industries they specialize Multiple:
in, the kind of customers they cater to, the From a fundamental point of view
scope of their operations, and so on.
(𝟏−𝐛)
𝐏𝟎 /𝐄𝟏 = 𝐫−𝐑𝐎𝐄∗𝐛
Determining the Multiples Used in Valuation:

In reality, a variety of different value multiples Where (1-b) is the dividend payout ratio, r is
are utilized. They can be organized into the the cost of equity, ROE is the return on equity,
following two major groups: and b is the plough back ratio.
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Example: The book value per share (B) =
(𝐒𝐡𝐚𝐫𝐞𝐡𝐨𝐥𝐝𝐞𝐫𝐬 𝐟𝐮𝐧𝐝𝐬−𝐏𝐫𝐞𝐟𝐞𝐫𝐞𝐧𝐜𝐞 𝐜𝐚𝐩𝐢𝐭𝐚𝐥)
V & S Company's Return on Equity is 20% and 𝐍𝐮𝐦𝐛𝐞𝐫 𝐨𝐟 𝐨𝐮𝐭𝐬𝐭𝐚𝐧𝐝𝐢𝐧𝐠 𝐞𝐪𝐮𝐢𝐭𝐲 𝐬𝐡𝐚𝐫𝐞
its r is 15%. Company's dividend payout ratio
The Most Important Factors That Determine
is 0.3 and its retention ratio 0.7.
the P/B Multiple:
So, from a fundamental point of view,
When viewed from the most fundamental
V & S Company's P/E multiple is: angle,
𝟎.𝟑 𝐏𝟎 𝐑𝐎𝐄(𝟏−𝐛)
𝐏𝟎 /𝐄𝟏 =𝟎.𝟏𝟓−𝟎.𝟐𝟎∗ 𝟎.𝟕 = 30 =
𝐁𝟎 (𝐫−𝐠)

Reasons for Using P/E Multiple: Where ROE is the return on equity, g is the
The application of the P/E multiple is growth rate, (1 – b) is the dividend payout
recommended for the following reasons: multiple, and r is the rate of return required by
equity investors.
a) Earnings potential is a significant factor in
determining investment value; as a result, Example:
earnings per share (EPS) play a significant role Virtual Limited's ROE is 25% and its r is 18% .
in valuing securities.
Victual’s dividend payout ratio is 0.5 and its g
b) Empirical data indicates that stocks with a is 15% .
low price-to-earnings ratio typically
From a fundamental point of view, Vestal’s
outperform the market.
P/B multiple is:
c) Management has some leeway to alter EPS
while still adhering to generally accepted
accounting principles, but this leeway is 𝐏𝟎 𝟎. 𝟐𝟓∗ 𝟎. 𝟓
= = 𝟒. 𝟏𝟕
limited. 𝐁𝟎 𝟎. 𝟏𝟖 − 𝟎. 𝟏𝟓

P/B Multiple: Reasons for Using P/B Multiple:

The denominator of the P/E multiple is the (a) Despite the fact that earnings per share can
earnings per share (EPS), which is a flow be negative, book value will almost always be
metric derived from the income statement. positive.

In contrast, the denominator of the P/B (b) Book value per share is more consistent
multiple, which is denoted by the letter B and than earnings per share (EPS).
stands for book value per share, is a stock
(c) According to findings from empirical
metric that is derived from the balance sheet.
studies, variations in the price-to-book ratio
(P/B multiple) are associated with variations in
long-term average returns.
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P/S Multiple both operating leverage and financial
leverage.
The P/S multiple is determined by dividing the
current stock price of a firm by the revenue d) There is some evidence from the real world
per share that the company has generated that implies that variations in the P/S multiple
over the course of the most recent twelve may be associated to variations in long-term
months. average returns.

Basic P/S Determinants: PEG:

𝐏𝟎 𝐍𝐏𝐌(𝟏 + 𝐠)(𝟏 − 𝐛) PEG Ratio is defined as the ratio of price to

=
𝐒𝟎 (𝐫 − 𝐠) earnings divided by the anticipated annual
growth rate in earnings per share.
Where NPM is the net profit margin ratio, g is
the growth rate, (1 – b) is the dividend pay-out 𝐏𝐄 𝐫𝐚𝐭𝐢𝐨
PEG ratio = 𝐄𝐱𝐩𝐞𝐜𝐭𝐞𝐝 𝐠𝐫𝐨𝐰𝐭𝐡 𝐫𝐚𝐭𝐞
multiple, and r is the rate of return required by
equity investors. The multiple of the P/B to the ROE, is known
as the value ratio.
Example:
𝐏/𝐁
VLC Limited has a NPM of 10% and a growth Value Ratio = 𝐑𝐎𝐄
rate 14%.
The multiple of P/S to NPM is referred to as
VLC dividend pay-out ratio (1 – b) is 0.4 and its PSM.
r is 0.19. 𝐏/𝐒
PSM 𝐍𝐏𝐌
From a basic point of view, VLC P/S multiple
are: The company is undervalued if the PEG
multiple is less than 1, whereas it would
𝐏𝟎 𝟎. 𝟏𝟎(𝟏. 𝟏𝟒) 𝟎. 𝟒 appear that the stock is overvalued if the PEG
= = 𝟎. 𝟗𝟏𝟐
𝐒𝟎 (𝟎. 𝟏𝟗 − 𝟎. 𝟏𝟒) multiple is greater than 1.
Why Use Price to Sales Multiple: Relative PE Ratio:
a) When compared to earnings per share and A company's price earnings ratio is measured
book value, sales are not as susceptible to in relation to the average for the market using
manipulation in general. relative price earnings ratios.
b) Even if EPS or book value is both in the red, Average PE ratio for the market:
sales will almost certainly be in the black.
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐏𝐄 𝐫𝐚𝐭𝐢𝐨 𝐟𝐢𝐫𝐦
Relative PE = 𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐏𝐄 𝐫𝐚𝐭𝐢𝐨
c) In general, revenues are more constant than 𝐦𝐚𝐫𝐤𝐞𝐭

earnings per share, which can be affected by

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ENTERPRISE VALUE MULTIPLES MODEL: Example:

The following are some examples of enterprise JJ Company's ROIC is 20% and its g is 11%.
value multiples that are regularly used: JJ's DA is 9% and its tax rate is 30%.
➢ EV/EBITDA multiple JJ's WACC is 13%.
➢ EV/EBIT multiple Calculate JJ's EV/EBITDA.
➢ EV/FCFF multiple 𝐄𝐕
➢ EV/BV multiple 𝐄𝐁𝐈𝐓𝐃𝐀
(𝟎. 𝟐𝟎 − 𝟎. 𝟏𝟏)∗ (𝟏 − 𝟎. 𝟎𝟗)∗ (𝟏 − 𝟎. 𝟑)
=
➢ EV/Sales multiple 𝟎. 𝟐𝟎(𝟎. 𝟏𝟑 − 𝟎. 𝟏𝟏)
= 𝟏𝟒. 𝟑𝟑
EV to EBITDA Multiple:
EV/EBIT Multiple:
The Enterprise Value to Earnings before
Interest, Taxes, Depreciation, and EV/EBIT ratio is defined as:
𝐄𝐧𝐭𝐞𝐫𝐩𝐫𝐢𝐬𝐞 𝐯𝐚𝐥𝐮𝐞 (𝐄𝐕)
Amortization (EV-EBITDA) multiple is defined
𝐄𝐚𝐫𝐧𝐢𝐧𝐠 𝐛𝐞𝐟𝐨𝐫𝐞 𝐢𝐧𝐭𝐞𝐫𝐞𝐬𝐭 𝐚𝐧𝐝 𝐭𝐚𝐱𝐞𝐬 (𝐄𝐁𝐈𝐓)
as follows:
Earnings before interest and taxes are
Enterprise value (EV) / Earnings before
earnings from operating assets, before taxes.
interest, taxes, depreciation, and amortization
𝐄𝐕
(EBITDA). A variant of this ratio is: 𝐄𝐁𝐈𝐓 (𝟏−𝐓𝐚𝐱)
So, the Equation can also be restated as The operating income after tax, also known as
EV/EBITDA= the net operating income after tax, serves as
(𝐌𝐚𝐫𝐤𝐞𝐭 𝐕𝐚𝐥𝐮𝐞 𝐨𝐟 𝐄𝐪𝐮𝐢𝐭𝐲 + 𝐌𝐚𝐫𝐤𝐞𝐭 𝐕𝐚𝐥𝐮𝐞 𝐨𝐟 𝐃𝐞𝐛𝐭−𝐂𝐚𝐬𝐡) the denominator of this multiple (NOPAT)
𝐄𝐁𝐈𝐓𝐃𝐀
Basic Determinants
Basic Determinants:
When viewed from the fundamental angle
When viewed from the most fundamental
angle 𝐄𝐕𝟎 (𝟏 − 𝐭)(𝟏 − 𝐫𝐞𝐢𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 𝐫𝐚𝐭𝐞)
=
𝐄𝐁𝐈𝐓𝟏 𝐖𝐀𝐂𝐂−𝐠
𝐄𝐕 (𝐑𝐎𝐈𝐎−𝐠 )∗ (𝟏 − 𝐃𝐀)∗ (𝟏 − 𝐭)
=
𝐄𝐁𝐈𝐓𝐃𝐀 𝐑𝐎𝐈𝐂(𝐖𝐀𝐂𝐂−𝐠 ) Where t is the tax rate, WACC is the weighted
average cost of capital, and g is the growth
Where ROIC stands for return on invested
rate.
capital, g is for growth rate, DA stands for
depreciation and amortization charges as a
percent of EBITDA, t stands for tax rate, and
WACC stands for weighted average cost of
capital.
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Example: 𝐄𝐕 𝐑𝐎𝐈𝐂−𝐠
=
𝐁𝐕 𝐖𝐀𝐂𝐂−𝐠
ABC Company has a tax rate of 30% and a
reinvestment rate of 70%. Where ROIC is the return on invested capital, g
is the growth rate, and WACC is the weighted
ABC WACC is 15% and growth rate is 12%.
average cost of capital.
Calculate EV/EBIT.
Example:
𝐄𝐕 (𝟏 − 𝟎. 𝟑)(𝟏 − 𝟎. 𝟕)
= =𝟕 Vivek Company has an ROIC of 18% , growth
𝐄𝐁𝐈𝐓 𝟎. 𝟏𝟓 − 𝟎. 𝟏𝟐
rate of 11% , and WACC of 13% percent.
EV/FCFF Multiple:
Calculate EV/BV.
The EV/FCFF multiple can be defined as:
𝐄𝐧𝐭𝐞𝐫𝐩𝐫𝐢𝐬𝐞 𝐯𝐚𝐥𝐮𝐞 (𝐄𝐕) 𝐄𝐕 (𝟎.𝟏𝟖−𝟎.𝟏𝟏)
= (𝟎.𝟏𝟑−𝟎.𝟏𝟏) = 3.5
𝐅𝐫𝐞𝐞 𝐜𝐚𝐬𝐡 𝐟𝐥𝐨𝐰 𝐭𝐨 𝐁𝐕

Basic Determinants: EV/Sales Multiple:

When viewed from the fundamental angle The definition of EV/Sales multiple is
Enterprise value (EV)/ Sales
𝐄𝐕𝟎
= 𝟏/(𝐖𝐀𝐂𝐂−𝐠 )
𝐅𝐂𝐅𝐅𝟏 Basic Determinants

Where WACC is the weighted average cost of 𝐄𝐕

=
𝐒
capital and g is the [𝐀𝐟𝐭𝐞𝐫 𝐭𝐚𝐱 𝐨𝐩𝐞𝐫𝐚𝐭𝐢𝐧𝐠 𝐦𝐚𝐫𝐠𝐢𝐧 (𝟏+𝐠) (𝟏−𝐫𝐞𝐢𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭 𝐫𝐚𝐭𝐞)]
(𝐖𝐀𝐂𝐂 – 𝐠)
Growth rate.
Where g is the growth rate and WACC is the
Example: weighted average cost of capital.
XYZ Limited's WACC is 16% and its g is 11%. Example:
Calculate EV/FCFF. Planned Limited's after-tax operating margin is
𝐄𝐕₁ 𝟏
= (𝟎.𝟏𝟔−𝟎.𝟏𝟏) = 20 11% and growth rate is 9%.
𝐅𝐂𝐅𝐅𝟏
Its reinvestment rate is 70% and the WACC is
EV/BV Multiple:
14%.
EV/BV multiple is defined as:
Calculate EV/S.
𝐄𝐧𝐭𝐞𝐫𝐩𝐫𝐢𝐬𝐞 𝐯𝐚𝐥𝐮𝐞 (𝐄𝐕)
𝐁𝐨𝐨𝐤 𝐯𝐚𝐥𝐮𝐞 𝐨𝐟 𝐚𝐬𝐬𝐞𝐭𝐬 (𝐁𝐕) 𝐄𝐕 [𝟎.𝟏𝟏(𝟏+𝟎.𝟎𝟗)(𝟏−𝟎.𝟕𝟎)]
= = 0.72
𝐒 (𝟎.𝟏𝟒−𝟎.𝟎𝟗)
Basic Determinants:

When viewed from the fundamental angle

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CHOOSING THE RIGHT MULTIPLES: ➢ The PEG multiple is best utilized by
companies that have low volatility in their
Prof. Swath Damodaran holds the opinion that
earnings per share growth rates and risk
we can adopt the multiple that best reflects
characteristics.
our prejudice (the cynical perspective), employ
all of the multiples (the bludgeon view), or ➢ The P/B multiple is better suited for
choose the "best" multiple. companies whose balance sheets represent
the market worth of their assets in a
The Cynical View:
manner that is at least somewhat accurate.
If we are looking to sell (purchase) a company,
➢ Companies with significant non-cash
we should select the multiple that provides
expenses are better suited to use the
the highest possible value. Despite the fact
EV/EBITDA multiple (depreciation and
that this may give the impression of
amortization).
manipulation rather than analysis, it appears
to be a practice that is rather widespread. ➢ The EV/FCFF multiple is more suited for
companies that have stable growth and
The Bludgeon View:
predictable capital expenditures.
There are three different approaches to taking
➢ The EV/sales multiple makes sense for
care of this.
companies that are still relatively young
1. The ability to arrive at a range of values that and have not yet established a track record
is generated by the different multiples. of positive profitability.

2. The ability to compute a straightforward Adjusting Book Values to Reflect Liquidation

average of the many values that have been Values:
produced by the various multiples.
Liquidation is the method that provides the
3. The option of calculating a weighted most accurate approximation of the fair
average, in which the relative importance of market value of those assets. If there is a
each number is reflected by the weight that is healthy secondary market for the assets, then
assigned to it. the liquidation values will be the same as the
prices on the secondary market.
The Best Multiple:
Problems with Asset-Based Valuation:
➢ In this context, the following points may be
noted: a. The assets that are included on the balance
sheet might not be actively traded, which
➢ The P/E multiple is more appropriate for
means that it might be difficult to obtain
companies that have (a) a demonstrated
accurate market values for them.
track record of positive earnings and (b) no
large non-cash expenses.
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b. Even if the information is available, market market value of the firm's equity and its
values may not accurately reflect the true market value of its debt are added together,
value of the asset due to inefficiencies in the the result is a total firm value for BML Limited
market. as of March 31, 2022 that is equal to Rs. 4,100
crores.
c. The value that an asset has in the market
may not be the same as the value that the
asset has in the particular use that the
company puts the asset to. Chapter-16: SPECIAL CASES OF
VALUATION
d. The process of identifying and appraising
omitted assets is fraught with difficulty, which
is one of the issues concerning these assets.
Independent & Cash-Flow-Generating
e. Even if individual assets can be located and Intangible Assets:
valued, it is likely that the total of the
Trademarks, Copyrights, and Licenses:
individual values of all identified assets will
not equal the value of the assets as a whole. The owner of a trademark, copyright, or
license has the sole authority to manufacture
STOCK AND DEBT APPROACH:
or sell the associated goods or render the
When a company's securities are traded on a associated service.
public exchange, the value of the company can
Franchises:
be determined by simply adding up the
current market value of all of the company's The owner of a franchise is granted the right
outstanding securities which is known as stock to promote and sell a company's branded
and debt approach or market-based approach. good or service under the franchise's name.
An illustration of a stock and debt approach is Examples include the Chain of Delhi Public
provided by the analysis of BML Limited's Schools.
valuation.
Approaches for valuation:
As of the 31st of March in 2022, the company
The 3 approaches are as under:
had a total of 25 crore shares in circulation.
Capital Investment:
The market value of BML's equity was Rs.
3,000 crores at the day's closing price of Rs. It follows the pattern that accountants use to
120. determine the value of other tangible assets
that are recorded in the books.
In addition, the company had outstanding
debt that had a market value of Rs. 1100 crore
as of the 31st of March, 2022. When the
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Discounted Cash Flow Valuation: measurement of how much better or worse a
firm is than its competition.
This will require isolating the percentage of an
organization's aggregate cash flows that can The Analysis Framework in General:
be attributable to its brand name or its level of
Challenges that are likely to appear at each
technological expertise and then discounting
level are;
back these cash flows at a rate that is
appropriate for the situation. Step 1: Assessment of the Enterprise's Current
Standing
Discounted Cash Flow Valuation:
Step 2: Revenue Growth Estimation
In order to properly evaluate real estate
investments by using discounted cash flow Step 3: Stable-growth Associated Operating
valuation, the following steps need to be Margin Estimation
taken:
Step 4: Estimate Reinvestment to Generate
a) Determination of the level of risk associated Growth
with real estate investments and basing your
Expected Growth = Reinvestment rate *
estimate of the appropriate discount rate on
Return on Capital
this level of risk.
Step 5: Risk and Discount Rate Estimates
b) Determination of an estimate of the
anticipated cash flows which are expected Step 6: Firm valuation
from the real estate investment over the
Value of Firm = Probability of surviving as a
course of the asset's life.
going concern × Discounted Cash Flow of Firm
Information Constraints: + (1- Probability of surviving as a going
concern) × Distress or Liquidation sale value
When determining the worth of a company,
one have to will look at information from Step 7: Estimating Equity Value and Per-Share
three different sources. Value:

1. To look at is the company's most recent set Value of Non-Operating Assets:

of financial statements.
When valuing a company, it is necessary to
2. The company's history, both in terms of its take into account its liquid assets, marketable
earnings and the prices it has been selling its securities, and holdings in other businesses,
products for. just as you would when valuing any other type
of business.
3. Estimate crucial inputs on risk, growth, and
cash flows by looking at the firm's competitors
or peer group in order to acquire a
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FIRMS WITH NEGATIVE OR LOW EARNINGS: Basic Models:

Companies that have negative earnings According to the fundamental dividend

because they have borrowed an excessive discount model, the value of a stock is equal to
amount of money and discuss the most the present value of the dividends that are
effective way to cope with the possibility that anticipated to be received from that specific
the company would default on its loans. The stock.
reasons why a company has negative earnings 𝐃𝐏𝐒
are; Value per share of equity = ∑𝐭=∞ 𝐭
𝐭=𝟏 (𝟏+𝐊 )𝐭
𝐞

➢ Companies Facing Momentary Challenges Where Depts. = Expected dividend per share in
period
➢ Concerns Unique to the Company
𝐊 𝐞 = Cost of equity
➢ Industry-Wide or Market-Driven Issues
t can vary from 1 to infinity
➢ Companies with Long-Term Issues
Inputs to Model:
➢ Strategic Issues
In general, it requires estimates of the
FINANCIAL SERVICE COMPANIES: following;
Financial service firms provide financial Cost of Equity:
products and services to corporate and non-
corporate customers and businesses. Cost of equity for a financial services company
needs to reflect the share of the risk in the
The special features of financial services equity that the marginal investor in the stock
companies include: is unable to diversify away. In the capital asset
a) Use of debt for earning income pricing model, a beta or betas are used to
evaluate this risk.
b) Heavily Regulated Sector
Payout Ratios:
c) Difficulty in measuring reinvestment
The estimated earnings per share in a future
d) Capital Adequacy Norms period can be multiplied by the expected
e) Difficulty in choice of multiples payout ratio to get at an estimate of the
expected dividend per share that will be paid
f) Issues faced for income estimation due to
out in that future period.
Provisioning for Losses
Expected Growth:
g) Government directives about the choice of
financial mix If the amount of dividends is determined by
earnings, then the predicted growth rate in
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earnings is the one that will be used to (If using net
calculate the value of the stock. income to
estimate
Earnings growth can be estimated in one of
cash flows
the following three ways:
to equity,
1. Historical Earnings Growth Rate you need to
remove
2. Analyst estimates in growth in earnings:
after-tax
3. Fundamental growth: interest
Expected 𝐠𝐫𝐨𝐰𝐭𝐡𝐄𝐏𝐒 = Retention ratio × ROE income.

Asset-based Valuation: Reinvestm Should Reinvestme

ent consider nt should
When conducting an asset-based valuation, reinvestment be only in
determine the value of a financial services in both operating
company's existing assets, deduct the amount operating assets
of debt and any other claims that are still due, assets and
and then report the difference as the equity's cash.
value.
Unlevered Should be Unlevered
Differences between Cash Valuation Beta the weighted beta of just
Approaches: average of the
Consolidated Separate the operating
Valuation Valuation unlevered assets.
beta of
Objective Value firm as Value non- operating
a whole with cash assets assets and
cash as part separately the beta of
of the assets. from cash. cash
Earnings Should Should (generally
include exclude zero).
interest interest Weights
income from income should be
cash and from cash based on
marketable and estimated
securities marketable values of
securities. operating
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assets and WARRANTS AND CONVERTIBLES:
cash.
Convertible bonds and stock are a kind of
Accountin Should be Should be traditional debt and preferred stock that
g returns measured measured additionally include a conversion mechanism,
using total using non- often known as a call option that allows the
earnings earnings, holder to convert the bonds or stock into
(including and cash shares of common equity at a predetermined
earnings should be price per share.
from cash) netted
and capital from
inclusive of capital Chapter-17: MERGER, ACQUISITION &
cash. measure. RESTRUCTURING
Growth Growth rate Growth
rate should rate should
reflect be only in Merger:
growth in operating A merger is the coming together of two
consolidated earnings. separate businesses into one.
earnings
Common types of mergers:
(including
earnings Horizontal Merger:
from cash).
The two businesses that have recently merged
Final The present The present are both operating in the same market sector.
Valuation value of the value of the
Vertical Merger:
cash flows cash flows
will already is the value This type of merger takes place when two
include cash. of the organizations that have a “buyer-seller”
operating relationship (or potentially have a buyer-seller
Do not add
assets. relationship) come together to form a single
cash to it.
entity.
Cash has to
be assed to Mergers between Conglomerates:
it.
These types of mergers actually involve the
consolidation of several distinct types of
enterprises into a single parent organization.
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Congeneric Merger: 12. Dubious Reasons for Mergers

These mergers represent an outward shift by 13. Diversification

the acquirer from its existing business
14. Lower Financing Costs
environment to other similar business
activities within the overall structure of the 15. Growth in Earnings
industry as a whole.
MECHANICS OF A MERGER:
Reverse Merger: A reverse merger occurs
The Company’s Act is the primary legislation
when a smaller, unlisted company acquires a
that governs the process of mergers and
larger, publicly listed company.
acquisitions in India. In addition to company
Acquisition: law, the Securities and Exchange Board of
India Act and the Competition Act also have
This term refers to the purchase of a
provisions that regulate mergers and
controlling interest in the share capital of an
acquisitions.
existing firm by one corporation from another
corporation. Legal Procedure of Amalgamation- A fairly
long process:
REASONS FOR MERGER:
The following procedures are typically
The following list contains the most typical
involved in amalgamation as part of the
reasons for mergers and acquisitions (M&A):
process:
1. Synergistic operating economics
a. An In-Depth Analysis of Object Clauses
2. Taxation
b. Communication with Stock Exchanges
3. Growth
c. Board Approvals of the Draft Amalgamation
4. The Consolidation of Production Capabilities Proposal
and the Enhancement of Market Power
d. Application to the NCLT/s
5. Economies of Scale
e. Notice to the shareholders and creditors of
6. Economies of Scope the company

7. Economies of Vertical Integration f. Conducting Meetings of Shareholders and

Creditors
8. Complementary Resources
g. Petition to the National Company Law
9. Utilization of Surplus Funds
Tribunal (NCLT) for the Confirmation and
10. Managerial Effectiveness Passing Orders
11. Industry Consolidation
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h. Filing the Order Copy with the Registrar of extraordinary labor crisis, or a significant tax
Companies relief.

i. Transfer of Assets and Liabilities Market Price per Share:

j. Issue of Equity and Debentures The exchange ratio could be determined by

looking at how the share prices of the
k. Competition Issues
acquiring company and the target company
COSTS AND BENEFITS OF A MERGER: compare to one another on the market.

The advantage of the merger is the difference Dividend Discounted (DD) Value per Share:
between the present value (PV) of the
The current value of the anticipated stream of
combined entity PVAB and the present value
dividends is what is meant to be represented
of the two entities if they are kept separate
by the dividend discounted value per share.
(PVA + PVB). Hence,
Discounted Cash Flow (DCF) Value Per Share:
Benefit = 𝑃𝑉𝐴𝐵 - (𝑃𝑉𝐴 + 𝑃𝑉𝐵 )
The DCF value per share is equal to:
EXCHANGE RATIO IN A MERGER:
(Firm value using DCF Method - Debt Value)
In a merger, the acquiring company would
No. of Equity shares
often offer the shares of its own company in
exchange for dose of the target company. The exchange rate can be calculated using the
relative DCF values per share of the companies
The offer is presented in the form of an
that are merging.
exchange ratio, also known as a swap ratio,
which is the number of shares that the PURCHASE OF A DIVISION / PLANT:
acquiring company is prepared to give up in
The purchase and selling of divisions or plants
return for one share of the target company.
is becoming increasingly widespread as a
Factors involved in Determining the Exchange result of the increased activity surrounding
Ratio: corporate reorganization.

Book Value per Share: Listed below are some notable examples from
the most recent years:
It is possible to calculate the exchange rate by
comparing the book values of each share held (a) TISCO's cement mill was purchased by
in each of the two companies. Lafarge.

Earnings per Share: (b) SRF Limited acquired the nylon type cord
division of CEAT.
The current earnings per share could be
affected by a number of one-time
circumstances, such as a windfall profit, an
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(c) Heinz India Limited was successful in its b) Consistent Cash flows.
acquisition of Glaxo India Limited's food
c) The opportunity for enhancing operational
business.
effectiveness.
TAKEOVERS:
d) Adaptability with regard to the sale of
A takeover often entails the acquisition of a assets that are no longer needed.
certain block of a business's equity capital,
e) Requirements for capital expenditures are
which grants the acquirer the ability to exert
quite low.
control over the operations of the company.
f) Easy Exit.
A takeover may be done through the following
ways: ACQUISITION FINANCING:

a. Open market purchase In recent years, the business sector in India

has been quite active in its pursuit of
b. Negotiated Acquisitions
acquisition opportunities worldwide.
c. Preferential allotment
Following is a list of characteristics that are
Regulation of Takeovers of Existing typical of purchase financing:
Companies:
a) Either the overseas subsidiary of the Indian
a. Transparency of the Process company or a special purpose entity formed
overseas for the purpose of acquisition
b. Interest of Minority Shareholders
receives the loan.
c. Realization of Economic Gains
b) On the basis of the guarantee offered by
d. No Undue Concentration of Market Power the Indian parent company, financing is
offered by international financial institutions
e. Financial Support
and by overseas branches of Indian banks.
LEVERAGED BUYOUTS:
c) When deciding whether or not to provide
A leveraged buyout is the process of financial assistance, lenders look at the
transferring control of a company while acquirer's cash flow.
primarily using debt as financing.
d) The cost of financing is determined by a
What Makes a Good LBO Candidate? number of factors, including the robustness of
the acquisition target, the ingenuity of the
When a company or division possesses the
parent company, the availability of legal
following qualities, it indicates that it is a
recourse to the lenders, and the type of debt
strong candidate for an LBO.
that the bank is participating in.
a) Good management team.
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BUSINESS ALLIANCES: existing products or services, a change in
personality or direction, a gateway to markets
A well-designed business alliance can be a
in other countries, and the purchase of
viable alternative to mergers and acquisitions
brilliant individuals or intellectual property.
in many different types of scenarios.
Five Sins of Acquisitions:
Here are some conspicuous examples:
a) Getting Way Too Far Away From It All
a) In the 1980s, General Motors and Toyota
came to an agreement to form a joint venture, b) Striving for Greatness
which was at the time unheard of.
c) Plunging without thinking
b) Over one hundred different companies and
d) Overpaying
organizations are Merck's partners in research
and development. e) Inability to Integrate Well

The Success Mantra: DIVESTITURES:

The following attributes are essential to the It refers to the act of a corporation selling one
growth and prosperity of a business of its divisions or undertakings to another firm
partnership: or forming an entirely new company out of the
remaining elements of its business.
a) The partners' respective strengths are
complementary to one another. Different Forms:

b) For a single company, the expense of The following is a list of the various ways in
producing a new product can be too which divestment, demerger, or divestitures
expensive. can be accomplished:

c) The partners are capable of working a) Complete or Partial Sale of Assets:

together to achieve their common goals.
The corporation sells a business unit or a
d) There is an unmistakable understanding of subsidiary to another entity because the entity
the purpose, the roles, and the obligations. is determined to be incompatible with the
primary business strategy of the parent
e) All of the persons involved consider the
company.
distribution of responsibilities and potential
benefits to be fair. b) Spin-off:

MANAGING ACQUISITIONS: This means that there is no change in

ownership. The management of the spin-off
A brand's value can be increased through
subsidiary, on the other hand, has been
mergers and acquisitions for a variety of
replaced.
reasons, including the improvement of
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c) Split-up: 7. Optimum utilization of

This necessitates the division of the entire DEMERGERS:

company into a number of independent spin-
A demerger is the process by which one
off companies (by creating separate legal
business transfers one or more of its
entities).
undertakings to another company. This can
d) Equity Carve Outs: involve more than one company.

In this case, some shares of the new firm are For instance, the Ahmadabad Advance Mills
sold in the market by making a public offer, was subdivided into two distinct businesses,
which results in cash being brought in. namely the New Ahmadabad Advance Mills
and the Tata Metal Strips.
e) The Demerger of Two Family-Owned
Businesses or Their Division:

They are founded on the synergy principle, Chapter-18: DEAL STRUCTURING AND
which states that the FINANCIAL STRATEGIES

f) Partial Selloff:

The process by which one company transfers An agreement between two parties (the
ownership of a business unit or asset to acquirer and the target firms) specifying their
another company. rights and obligations is known as a deal
structure. The procedure that leads to the
HOLDING COMPANY:
formation of this agreement is referred to as
A holding company is a corporation that owns the deal-structuring process.
the equity of multiple other companies in
PAYMENT AND LEGAL CONSIDERATIONS:
order to exert influence over those companies.
The overall consideration, which can come in
The following are some of the other benefits
the form of cash, common stock, or debt, or
that come with running a holding company:
even a combination of all three of these
1. Central control things, can be considered the method of
payment.
2. Flexibility for growth
Form of Acquisition Vehicle and Post closing
3. Continuity and succession planning
Organization:
4. Tax planning
When deciding on an acquisition vehicle or
5. Risk mitigation post-closing consideration the elements listed
below:
6. Legal protection for valuable assets of the
group funds
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(a) The cost and level of formality involved in 3. Mix of Cash and Stock
the organization
4. Convertible Securities
(b) The ease with which ownership can be
TAX AND ACCOUNTING CONSIDERATIONS:
transferred
Accounting concerns address the influence on
(c) The continuous existence of the
future earnings of the combined firms that will
organization
be caused by the requirements for financial
(d) Management control reporting. Tax considerations involve the
establishment of tax structures to ascertain
(e) The convenience of obtaining financial
whether or not a transaction will result in
support
taxable income for the shareholders of the
(f) Ease of assimilation into the system selling company.

(g) The manner in which earnings shall be TAX RELIEFS & BENEFITS IN CASE OF
distributed AMALGAMATION IN INDIA:

(h) The scope of individual responsibility If an amalgamation takes place within the
meaning of section 2(1B) of the Income Tax
(i) Taxation.
Act, 1961, the following tax reliefs and
Selecting the Appropriate Acquisition Vehicle: benefits shall be available:
The corporate structure that is most Tax Relief to the Amalgamating Company:
frequently utilized is the acquisition vehicle,
Exemption from Capital Gains Tax [Sec.
because it provides the majority of the
47(Vi)]:
attributes that buyers want.
Under section 47(vi) of the Income-tax Act,
Selecting Suitable Post-Closing Organization:
capital gain arising from the transfer of assets
It is possible for the post-closing organization by the amalgamating companies to the Indian
to be identical to the one selected for the Amalgamated Company is exempt from tax as
acquisition vehicle. Structures such as such transfer will not be regarded as a transfer
divisional and holding company arrangements for the purpose of Capital Gain.
are frequently used after a closing.
The two conditions that must be satisfied, are;
Different Types of Payment Consideration:
a). The scheme of amalgamation satisfies the
The following is a list of the various types of conditions of Section 2(1B); and
payment that are accepted:
b). The amalgamated company is an Indian
1. Cash Company.
2. Non-cash
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Allotment of Shares in Amalgamated Company Benefits under this section with respect to
To The unabsorbed depreciation and carry forward
losses are available only if the followings
Shareholders of Amalgamating Company
conditions are fulfilled:
[Section 47(Vii) & 49(2)]
There should be an amalgamation of:
Any transfer by a shareholder in a scheme of
amalgamation of shares held by him in the (a) a company owning an industrial
amalgamating company shall not be regarded undertaking (Note 1) or ship or a hotel with
as transfer if- another company,

a). Transfer is made in consideration of (b) A banking company referred in section 5(c)
allotment to him of shares in the of the Banking Regulation Act, 1949 with a
amalgamated company; and specified bank (Note 2), or

b), amalgamated company is an Indian (c) One or more Public Sector Company or
company. Section 49(2)-provides that in above companies engaged in the business of
case the Cost of Shares of the amalgamating operation of aircraft with one or more public
company shall be the Cost of Shares to the sector company or companies engaged in
amalgamated company. similar business.

Tax Relief to the Shareholders of the Note 1. The term 'Industrial Undertaking' shall
Amalgamating Company: mean any undertaking engaged in:

Exemption from Capital Gains Tax [Sec 47(vii)] (i) The manufacture or processing of goods, or

Under section 47(vii) of the Income-tax Act, (ii) The manufacture of computer software, or
capital gains arising from the transfer of
(iii) The business of generation or distribution
shares by a shareholder of the amalgamating
of electricity or any other form of power, or
companies are exempt from tax as such
transactions will not be regarded as a transfer (iv) Mining, or
for capital gain purpose, if: a). The transfer is
(v) The construction of ships, aircrafts or rail
made in consideration of the allotment to him
systems, or
of shares in the amalgamated company; and
b). Amalgamated company is an Indian (vi) The business of providing
company. telecommunication services, whether basic or
cellular, including radio paging, domestic
Tax Relief to the Amalgamated Company:
satellite service, and network of trucking,
a. Carry Forward and Set Off of Accumulated broadband network and internet services.
loss and unabsorbed depreciation of the
amalgamating company [Sec. 72A]:
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Note 2. (i) Specified bank means the State amalgamating company or to ensure that the
Bank of India constituted under the State Bank amalgamation is for genuine business
of India Act, 1955 or purpose.

(ii) a subsidiary bank as defined in the State H) The amalgamated company, which has
Bank of India (Subsidiary Bank) Act, 1959 or acquired an industrial undertaking of the
amalgamating company by way of
(iii) a corresponding new bank constituted
amalgamation, shall achieve the level of
under section 3 of the Banking Companies
production of at least 50% of the installed
(Acquisition and Transfer of Undertaking) Act,
capacity of the said undertaking before end of
1980.
four years from the date of amalgamation and
B) The amalgamated company should be an continue to maintain the said minimum level
Indian Company. of production till the end of five years from
the date of amalgamation.
C) The amalgamating company should be
engaged in the business, in which the The Central Government may relax above
accumulated loss occurred or depreciation condition in desired situations.
remains unabsorbed, for 3 years or more.
I) the amalgamated company shall
D) The amalgamating company should hold electronically furnish to the AO a certificate in
continuously as on the date of amalgamation Form 62 duly verified by an accountant, with
at least three fourth of the book value of the reference to the books of account and other
fixed assets held by it two years prior to the documents showing particulars of production
date of amalgamation. along with the return of income for the AY
relevant to FY falling within a period of five
E) The amalgamated company holds
years from the date of amalgamation.
continuously for a minimum period of five
years from the date of amalgamation at least The requirements of furnishing Form 62 will
three-fourths in the book value of fixed assets arise for the first time only when
of the amalgamating company acquired in a amalgamated company fulfils conditions of
scheme of amalgamation achieving level of production of 50% of
installed capacity of undertaking of
F) The amalgamated company continues the
amalgamating company within four years
business of the amalgamating company for a
period.
minimum period of five years from the date of
amalgamation. Consequences When Above Conditions Are
Satisfied:
G) The amalgamated company fulfils such
other conditions as may be prescribed to If the above conditions are satisfied then
ensure the revival of the business of the accumulated business loss and unabsorbed
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depreciation of the amalgamating company MAT Credit which was available to the
shall be deemed to be business loss and amalgamating / demerged company.
unabsorbed depreciation of the amalgamated
Capital Gains Taxes:
company for the previous year in which
amalgamation is affected. If the shares qualify as capital assets under
Section 2(14) of the ITA, the gains arising upon
Consequences When Above Mentioned
transfer of the shares would attract capital
Conditions Are Not Satisfied After Adjusting
gains tax liability.
Business Loss/ Depreciation - In case the
above specified conditions are not fulfilled As per Section 45, capital gains tax must be
then that part of brought forward loss and assessed at the time of transfer of the capital
unabsorbed depreciation which has been set asset, and not necessarily at the time when
off by amalgamated company shall be treated consideration is received by the transferor or
as income of the amalgamated company for on the date of the agreement to transfer.
the year in which failure to fulfill above
Tax issues in Domestic M&A:
conditions occurred.
These issues typically cover the following
Availability of MAT credit:
cases:
Section 115JB of the ITA levies MAT on a
(a) Allotment of securities or payment of cash
company if the amount of income-tax payable
consideration to shareholders of
under general provisions of the ITA is less than
amalgamating company
15% of the company's 'book profits'.
(b) Part consideration paid directly to
In such case, the book profits' computed are
shareholders of demerged company
deemed to be the total income of the
company and income-tax is levied thereon at (c) Availability of MAT credit
15%.
(d) Merger of Limited Liability Partnership into
However, the excess of MAT paid over normal a company
tax liability for the year is permitted to be
Tax Issues in Cross Border M&A:
carried forward under Section 115JAA of the
ITA for set-off in future years in which normal In cross-border transactions, tax concerns
tax liability exceeds MAT liability ("MAT emerge when two countries seek to tax the
Credit"). same income or the same legal entity,
resulting in double taxation of the money.
There is no express provision in Section
Most countries, in order to promote
115JAA which allows an amalgamated/
cooperation, trade, and investment, countries
resulting company to carry forward and claim
enter bilateral DTAAS to limit their taxing
rights voluntarily through self-restraint,
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thereby avoiding overlapping tax claims. The 2. Internal accruals
availability of DTAA benefits and the ultimate
3. Long Term loans from banks or other
tax liability frequently drive or impede cross-
lenders
border transactions.
4. Issue of convertible/non-convertible
FINANCIAL REPORTING OF BUSINESS
debentures or other types of domestic or
COMBINATIONS:
foreign debt instruments.
An entity shall account for each business
FINANCING OF CROSS BORDER ACQUISITIONS
combination by applying the acquisition
IN INDIA:
method.
In India, cross-border acquisitions are typically
Applying the acquisition method requires:
divided into the following two categories:
(a) Identifying the acquirer;
Inbound acquisitions, in which an
(b) Determining the acquisition date international acquirer purchases the shares of
an Indian target.
(c) Recognizing and measuring the identifiable
assets acquired, the liabilities assumed and Outbound acquisitions, in which an Indian
any no controlling interest in the acquire; and acquirer acquires a company incorporated
outside India directly or through an outside
(d) Recognizing and measuring goodwill or a
India-incorporated special purpose vehicle
gain from a bargain purchase.
(Offshore SPV).
DEAL FINANCING:
The Fund-Raising Structures:
M&A deals are frequently financed using cash,
The funds can be raised through the following
stock, debt, or a combination of all three.
modes:
The choice of financing source or sources is
Inbound Acquisition Finance: Offshore
influenced by a number of variables, such as
Acquirer:
the state of the capital markets, the liquidity
and creditworthiness of the target and The offshore purchaser will establish a special
acquiring companies, the combined borrowing purpose vehicle outside of India known as an
capacity of the target and acquiring FDI SPV for the purpose of acquiring shares of
companies, the size of the transaction, and the an Indian target through the channel of
target shareholders' preference for cash or foreign direct investment (FDI) into India.
acquirer shares.
Inbound Acquisition Finance: FOCC:
The various financing options, available to an
Foreign Owned and Controlled Company
acquirer are:
(FOCC) is not permitted to use leverage in the
1. Issue of equity and/or preference shares Indian market in order to purchase shares,
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hence a FOCC is unable to obtain acquisition placement. However, investors are not
financing from Indian banks, financial permitted to use the proceeds from unlisted
institutions, or Indian funds. NCDs to purchase securities on the capital
market.
Outbound Acquisition Finance:

The following types of finance structures are

commonly utilized

(a) Onshore financing:

An Indian company is able to raise loans from

Indian banks in order to complete an
outbound acquisition, unless the
circumstances are particularly exceptional. An
Indian acquirer can also raise finances from
NBFCs in India or raise funds via issuing of
NCDs, which can, among other things, be
subscribed to by domestic mutual funds, AIFs,
and FPIs.

(b) ECB:

ECB can be used by Indian companies for

acquisition of shares of an overseas joint
venture or wholly owned subsidiary.

Financing from Offshore Sources:

Indian acquirer will establish an offshore

special purpose vehicle (SPV) in order to
purchase the target in accordance with the
criteria pertaining to overseas direct
investments that were published by the RBI
(ODI Guidelines).

Domestic Acquisition Finance:

The majority of the time, financing for

domestic acquisitions is organized as NCDs or
loans from NBFCs. Equity investments are one
of the possible uses for the money received
from the sale of NCDs through private