Mergers & Acquisitions

January 27 / TA Session / Eric Rinder

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General Information

• Will typically meet for an hour starting at– First Four Weeks: Tuesday 4:20 pm (JG 103)

and Wednesday 11:00 am (JG 107), 4:20 pm (JG 104)

• Email: edr2116@columbia.edu• TA website: www.clsmanda.wordpress.com– TA session schedule– TA materials

• Please don’t hesitate to reach out with questions or concerns

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TA Session Goals

• Facilitate discussion• Provide help with difficult material• Help pull course together with an eye

towards the exam

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Merger Agreements

• Help solve adverse selection problem– Representations and warranties– Securities laws supplement merger agreements for publicly

traded companies and IPOs

• Help solve moral hazard problem– Performance-based compensation

• Help apportion risk– Material Adverse Change clause: who bears the risk of

market collapse?– Financing condition: who bears the risk of financing

unavailability?

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Valuation Under Certainty

• When risk is removed, all that matters is timing– e.g. $1 today is better than $1 tomorrow

• Present value is a function of:– The length of time until the money will be

received– The discount rate (i.e. the risk free interest

rate…U.S. Treasury bills)

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Capital Budgeting

• Compare initial capital outlay with present value of future cash flows

• Allows planners to choose highest value allocation of capital

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Chapter 2 Problems

1. $0.9432. $1.063. $145.124. 3.02%5. Investment 26. (a) 33.3% / (b) $15,9097. Bank A8. $100,000 today9. (a) stream of $100 payments / (b) stream of payments10. Weekly11. Yearly12. Must compensate investor for the opportunity cost of

forgone investments

Problem 1, CB 79• How much must you invest today at 6% to have $1 at

the end of one year?• Present Value Equation: PV = FV/ (1+r)n

– PV = $1 / (1.06) = $.943

PV= Present ValueFV= Future Value R= Interest rate N= Number of times compounded

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Problem 2, CB 79• Assuming rate of interest of 6%, how much do you

have in 1 year if you invest $1 today?• Terminal Value Equation (annual compounding): – TV = X0 (1+r)– TV = $1 * (1.06) = $1.06

TV= Terminal valueXO= Initial valueR= Interest Rate

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Problem 3, CB 79• What was your initial deposit, assuming an account

balance of $162.52 one year later and 12% interest rate?

• Present Value Equation: PV = FV/ (1+r)n

– PV = $162.53 / (1.12) = $145.12

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Problem 4, CB 79• If you deposited $734,011 in your bank account and

have $756,213 one year later, what is the interest rate?

• Present Value Equation:– PV = FV/ (1+r)n

– r = (FV/PV) – 1– r = ($756,213/734,011) – 1 = .0302 = 3.02%

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Problem 5, CB 79• Which project has a higher net present value?• Present Value Equation: PV = FV/ (1+r)n

• In a world without risk, Option 2 has a higher net present value and is a better investment

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Option 1 Option 2

Capital Outlay $250,000 $250,000

Year 1 $300,000 $400,000

Problem 6(a), CB 79• What is the rate of return if you invest $75,000 today

for a payback of $100,000 in one year?• Present Value Equation: – PV = FV / (1 + r)n

– r = (FV/PV) – 1– r = ($100,000/75,000) – 1 = 0.333

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Problem 6(b), CB 79• Invest $75,000 today for a payback of $100,000 in one

year. At a discount rate of 10%, what is the net present value?

• Present Value Equation:PV = $100,000 / (1.10) = $90,909NPV = $90,909 - $75,000 = $15,909

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Problem 7, CB 79• Bank A pays 6% interest compounded annually. Bank

B pays 5.8% interest compounded quarterly. Which bank is better?

• Terminal Value Equation (non-annual compounding): TV = X0 (1+r/m)m

– Bank A ($1 invested for 1 year)• TV = $1 * (1.06) = $1.06

– Bank B ($1 invested for 1 year)• TV = $1 * (1 + .058/4)4 = $1 * (1.0145)4 = $1.0593

• Bank A is better

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Problem 8, CB 80• If interest rate is 10%, which is better: $100,000 today

or $1,000,000 in 25 years?• Present Value Equation: PV = FV / (1 + r)n

PV = $1,000,000 / (1.10)25 = $92,296

• $100,000 today is better

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Problem 9(b), CB 80• Option 1: $375 today• Option 2: Series of cash flows over time• Present Value Equation: PV = FV / (1 + r)n

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Option 1 Option 2

Now $375

Year 1 $100 / (1.10) = $90.90909…

Year 2 $100 / (1.10)2 = $82.64463…

Year 3 $100 / (1.10)3 = $75.13148…

Year 4 $100 / (1.10)4 = $68.30135…

Year 5 $100 / (1.10)5 = $62.09213…

Total $375 $379.08

Problem 9(b), CB 80• Option 1: $375 today• Option 2: Series of cash flows over time• Present Value Equation: PV = FV / (1 + r)n

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Option 1 Option 2

Now $375

Year 1 $50 / (1.10) = $45.4545…

Year 2 $100 / (1.10)2 = $82.64463…

Year 3 $100 / (1.10)3 = $75.13148…

Year 4 $100 / (1.10)4 = $68.30135…

Year 5 $100 / (1.10)5 = $62.09213…

Year 6 $100 / (1.10)6 = $56.44739…

Total $375 $390.07

Problem 10 and 11, CB 80• Problem 10: Better to be paid weekly, biweekly, or

monthly?– Weekly is better because you start receiving money earlier.

• Problem 11: Better to pay interest monthly, quarterly, or annually? – Terminal Value Equation: TV = X0 (1+r/m)m

– Assuming $100 loan repaid after 1 year:• Monthly: TV = $100 (1 + .1/12)12 = $110.47• Quarterly: TV = $100 (1 + .1/4)4 = $110.38• Annually: TV = $100 (1 + .1) = $110

– Better to pay annually

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Problem 12, CB 80• Why would you expect the rate of interest to be

greater than zero?– Yes because you must compensate the investor for the

opportunity cost of forgone investments.

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