Could anyone please explain the intuition behind this formula?
S = V(AT) - V(A) - V(T) + C
S = synergies
V(AT) = value of combined firm
V(A) = value of acquirer
V(T) = value of target
C = cash paid
The part I don’t get is the cash paid. Basically we are saying Synergies = Diff between value of combined vs 2 individual firms (which is essentially synergy) + cash paid.
What does synergy have to do anything with cash paid?
I feel it should just be S = V(AT) - V(A) - V(T)
Thanks!
The formula is:
Value of Original Company + Value of Target + Synergies - Cash Paid
Divided by
Total shares of original company
Why cash decreases? Because if you paid cash, you’re dropping your value and gaining the value of the target and the synergies.
Thanks, I understand that but it doesn’t make sense to me intuitively that cash is added in the formula S = V(AT) - V(A) - V(T) + C.
Algebraically it makes sense but not intuitively.
The equation of Value of Original Company + Value of Target + Synergies - Cash Paid is very institutive as a numerator in calcuating total value per share.
When view it from V(AT) angle, its a lot different. You are now looking at if a cash offer was made or if a stock offer was made, and how the new shares differed from the old shares. I would assume that if you paid cash, the formula is that way to account for the value due to non-dilution of the shares.
But I tend not to think that deep for this exam.
What, exactly, do you mean by “intuitively”?
I mean what does cash have to do with synergies?
I feel synergies should just be S = V(AT) - V(A) - V(T)
If you’re worth $100 and you spend $10 on a Monet, is your new value $100 + V(Monet)?
If I’m worth $100 and I spend $10 on a Monet. My new worth is $90 + V(Monet).
If value of the Monet is $20, my new worth will be $90 + $20 = $110.
What am I missing here? I can’t seem to understand why cash would affect the value of synergies.
What it affects (decreases) is the after-merger value of the acquiring company, just as purchasing the Monet affected (decreased) your after-purchase value.
I see, I think I get it now.
The value of the combined company was reduced by cash, therefore, the value of synergies was also reduced by the cash amount. So to get back the value of synergies we need to add back cash.
Correct?
Thanks, Bill.
Correct.
And you’re quite welcome.