My company has enjoyed a good run of success, and is now considering purchasing a competitor in order to expand further. After twelve years of business, we have expanded, becoming profitable, and are now franchising as well. In order to adopt a nationwide strategy with an eye to going global, we are looking at options for expansion. Taking over a competitor is one of the main options. This paper will analyze the idea of taking over a competitor, especially with respect to how to finance such a transaction.
Different Valuation Methods
There are several valuation methods that can be used to analyze the competing company. These are adjusted book value, capitalized adjusted earnings, discounted future earnings, the cash flow method and the gross revenue multiplier (Collin.edu, 2013). Another technique is to base the valuation on the stock market valuation of a similar company. The company we are going to take over is a private company, but we can in theory use a public company as a comparable. Given the size of the company that we are seeking to take over, however, there does not appear to be a good public comparable. Therefore, this option is being rejected. The other five options are focused along the lines of analyzing the financial statements of the prospective takeover. Clearly, if the company is looking to sell, we can acquire these statements.
The adjusted book value of the operation method reflects that we are paying for the firm's assets. This makes sense because we have our own brand and management systems. The assets are the key thing that we are acquiring, and that includes the established customer base. Thus, by taking the book value of the company and making adjustments for assets and liabilities that are not on the balance sheet, and then paying a slight premium, we can arrive at an adjusted book value.
Basing the price on the capitalized annual earnings is another method. The annual earnings are accounting profits, which is an issue because we are paying cash. Therefore, it might be better to use cash flows. In addition, it is worth noting that many firms that are taken over might not have earnings -- they are on the market because they are losing money. We know from our tough road to success that many companies in the industry can become unprofitable if there are issues with either management or the local economy. If we assume that there is only limited profitability in the industry we should not use this valuation methodology.
Discounted future earnings are perhaps more valuable then, because they focus on the earnings in the future under our management rather than the past under the old management. It might be better to use cash flows, which is a flaw in the capitalized annual earnings methodology as well. Nevertheless, accounting profit is a good starting point, if for no other reason than the stock market also values companies based on accounting profit. By using the expected future earnings under our management, we are taking a more realistic view of what the value of the company is to us.
The cash flow method focuses on cash flows only, discounted. The past year's cash flows are assumed to flow in perpetuity, which is not particularly realistic, but there is certain room in this model for adjustments. The best idea would be to adjust the cash flows so that an expected level of current cash flow plus future growth is incorporated into the model. This method is the most appropriate for valuing a non-public acquisition because it allows the purchaser to estimate the value that the firm has to the acquirer. A sensitivity analysis can be conducted, and the acquirer can set a maximum value on what it is willing to pay for the acquisition.
The gross revenue multiplier takes the current gross revenue and applies a multiplier to that figure. This method isn't nearly as good as the cash flow method because it focuses only on revenues, but other cash flows from the expense side can have a significant impact on the overall value of the firm. This is especially true when the cost structure of the acquired company is likely to…