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Zzzz

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EACC: Real Options on M&A
Case 1: The Value of a Company with an Option to
Expand
Firm Z is facing the chance to expand its business. Currently, the value of the assets in place of this company is e18M. The company has the chance to expand its business in 30% with an investment cost of e4M. The volatility is 20%, the dividendyield is 6% and the risk-free rate is 2%.
Case questions:
1. What is the value of this company?
2. Describe, based on the real option approach, what are the characteristics of the optimal decision.

Case 2: The Optimal Timing for Merging I
Firm C is facing the chance to acquire Firm D. Consider the following information about this operation:
Expected value after the acquisition

e67M

Value of company C (stand alone)

e31M

Value of company D (stand alone)

e24M

Volatility of the synergies

25%

”Dividend-yield”

5%

Risk-free rate

3%

Expected merging costs (consultancy, legal costs, integration costs, ...)

Case questions:

1

e2.5M

1. Assuming the price paid for company D corresponds to its market value, what’s the optimal trigger for merging?
2. Assuming the shareholders of company D demand a premium of 20% for the operation, what should the managers of company C do?
3. Determine the terms that turn the shareholders of company C indifferent about an immediate acquisition.
4. Assume that there are no other companies interested to buy company D, and D is always a target (and never a bidder). Regarding the situation presented in 2) what is the market value of company C.

Case 3: The Optimal Timing for Merging II
The management teams of SSSONAECOM and ZZZON want to merge creating a bigger Telecom Company. The synergies they will have arise mainly from a better market position and lower fixed and variable costs. The managers of both companies believe the synergies can achieve 15% of the market value of both companies. However, they know that the market conditions are extremely hard which may have an important impact on the future value of the synergies. Based on the collected information they estimate that the volatility of the value of the synergies is similar to the volatility of the company’s stocks (portfolio). The managers of both companies have been postponing the decision to merge, waiting for the optimal timing, mainly because the outcome is uncertain and the merging costs are significant and irreversible.
Based on the available information, can you help them?

2

Market value of SSSONAECOM

e760M

Market value of ZZZON

e520M

Volatility of SSSONAECOM shares

28%

Volatility of ZZZON shares

25%

Correlation

0.75

Expected merging costs (consultancy, legal costs, integration costs, ...)

e110M

”Dividend-yield”

6%

Risk-free rate

3%

Case questions:
1. Find the optimal timing for merging, i.e., the level of synergies for which is optimal to merge;
2. Perform a sensitivity analysis to the volatility parameter;
3. Analyze the effect of a ”golden parachute” of e8M on the timing of the merger.

Case 4: M&A to Acquire New Technology I
NNNokkkia, a company acting in the mobile phone industry, decided to make an offer to buy a company that has expertise about the development of new long-lived batteries.
The goal is to control a new technology taking advantage over the competitors. The target company has already started the the research phase (e1M have been already invested) which will last for two more years. For supporting the remaining research period the company needs to invest now e1.5M more. After the R&D period the product can be patented and the company can start producing and commercializing it, if the market conditions reveal adequate. The production facility has a cost of e4.5M and the present value of the expected cash flows is e6M. However, the uncertainty surrounding the project is significant: the firm estimates a volatility of 30% for the cash flows. If NNNokkkia decides to acquire the company a synergy of e2M is expected.
The risk free rate is 3%.
3

Case questions:
1. What’s the value of the target firm for its shareholders?
2. What’s the value of the target firm for NNNokkkia?
3. What’s the maximum price should NNNokkkia admit to pay?

Case 5: M&A to Acquire New Technology II
APPPPPLE, a company acting in the tablet and phone industry, decided to make an offer to buy a company that has good expertise on the development of special glasses for touch screens. The target company has already started an R&D phase for the new generation touch screens. The total cost for the research phase is EUR 4M, part of it was spent last year, and a remaining EUR1.5M is going to be spent this year.
After this, two more years will be needed to conclude the research period. After the
R&D period the product can be patented and the company can start producing and commercializing the new screens, if the market conditions reveal adequate. The patent and the production facilities have a cost of EUR 7.5M and, today, the present value of the expected cash flows is EUR 8M. However, the uncertainty surrounding the project is significant: the firm estimates a volatility of 35% for the cash flows. If APPPPPLE decides to acquire the company, a synergy of EUR 2M is expected. The risk free rate is 3%.
Case questions:
1. Using the binomial method determine the value of the target firm for APPPPPLE.
2. Using the binomial method determine the value of the target firm for its shareholders.
3. What’s the maximum price that APPPPPLE should admit to pay for the target company? 4. What’s the minimum value of synergies that gives the company a 100% certainty about the investment in production phase? What’s the value of the target company in that case?

4

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