Net Present Value Mergers and Acquisitions

NPV Obviously the easiest and most error-free way of doing this is in Excel. Thus, we get the following table for the NPV calculation. Flow NPV (1-5) $2,031,369.67 Total NPV $281,369.67 Google should accept the project, because it has a positive net present value. All projects with a positive net present value add to shareholder wealth. Unless there is a comparison between two mutually exclusive projects, any project with a positive NPV should be accepted.

In Google's case, given how much cash it has, it is hard to imagine that this project would be mutually exclusive to another. How Acquisitions Work The argument for an acquisition is that the purchasing company feels that the combined value of the two firms is greater than the sum of the parts. The first assumption is that markets are efficient, such that the stock price of Groupon reflects the expected present value of its future cash flows.

Thus, if Google buys Groupon at the current market value, it will receive fair value for the transaction. The second assumption is that there needs to be a premium to entice Groupon shareholders to sell their company to Google. Indeed, if the shareholders know that Google wants to buy a controlling interest in the company, as profit-seekers they will make their shares scarce until the price comes up. Thus, Google must pay more than fair market value for the Groupon shares.

This leads to the conclusion that Google needs to believe that the combined value of the two companies is going to be greater than the sum of the two parts. The sum of the two parts reflects the current market price of these. Google is already going to pay more than that. Plus, Google needs to earn a return greater than its hurdle rate on the acquisition.

As such, for this deal to add value to Google's shareholders, it must believe that it can add substantially more value to Groupon, or that Groupon will add substantially more value to Google, in order to justify the acquisition. This is why acquisitions are risky, because this added value is based entirely on assumptions about what the two companies or combined entity will look like post-merger. Benefits to Shareholders of Groupon and Google Obviously, a Google acquisition will add value for Groupon shareholders.

By definition, if the acquisition has gone through, Google has paid a premium to Groupon shareholders above fair market value, so this means that they have acquired value. The only real downside would be if this is a cash deal. An equity deal would be better for Groupon shareholders because they would then receive some of Google's upside value. Many of Groupon's shareholders are likely invested in the company as a growth stock, seeking substantial upside.

While a Google acquisition would lock in some upside, it would also cut the investors out of what might have been quite a bit more. A cash deal would therefore probably come at a higher cost than an equity deal. While Groupon shareholders certainly gain in the short run they might feel that they are missing out on potential long-term gains as well. But these are potential and speculative, while real value is created in the short run.

A purely rational Groupon investor would certainly take a Google purchase as a win. One cannot say at the time of a merger, and certainly not before, whether or not the merger will be positive for Google. That is pure speculation about the future. There are no resources that will inform this view -- journal articles write about the past, not the future, and any business press article on the subject will be an opinion piece just as speculative as my own personal opinion.

While this is an opinion, I personally do not see value for Google in Groupon. There are two ways of looking at this. The first way is that Google has an incredible amount of cash, which is earning not much. It's cost of capital is a lot lower than the 14% used in the example above. Since Google is earning basically nothing on its cash supply, most investments that have a positive return would be worth doing from a strictly NPV point-of-view. However, there is a strategic point-of-view at work here.

While Google is definitely a better-run company than Groupon and can surely make more money with Groupon's assets than Groupon can, Google has a number of other projects that it is working on that quite frankly have better long-term potential. This is a company that thinks big, and wants to be a game-changer when it enters a business. I do not see Groupon as a game-changer. The rate of return is probably not going to be that high, because Groupon is, at its heart, a discounting service and sales channel.

You promote through it, but I do not see massive long-term growth potential there. Unless Google knows something I don't -- and let's face it they probably do -- I cannot imagine Groupon being worth the distraction when there are genuine opportunities for game-changing technological advances that offer Google much better opportunities for the future. Financial Conditions of the Companies It should be noted that the financial conditions of these companies is irrelevant. Google has $50 billion in cash and Groupon has a market cap of $7.24 billion.

Google could buy Groupon with cash, or a couple of shares of its stock. Google has a market cap of $384 billion. So Google would not lose a lot of sleep thinking about the cost of acquiring Groupon. Even less relevant is the project discussed in Part I, which I think might have been a decision to switch tuna suppliers at the company sushi bar, given the impact it will have on Google's finances.

Potential Benefits The theoretical value in an acquisition lies in the synergies that might come about that would render the combined entity more valuable than the two entities separate, accounting also for the acquisition premium that is paid by Google. It is not difficult to imagine that greater access to Google's data will allow Groupon to better target consumers, and at a lower price, and this will probably add a lot of value to Groupon's business. It is up to Google and Groupon to put a dollar value on that.

Groupon itself probably does not enhance Google's offering, which is data-driven. Google attracts traffic better than Groupon, and understands how to match advertisers to customers better than Groupon. The potential benefits therefore are almost entirely on the Groupon side of things. Potential Pitfalls of Acquisitions This highlights one of the pitfalls with acquisitions. From a managerial perspective, the ability to do a lot of things well at any given time is a skill that must be built in an organization.

Google is not General Electric -- they are really only good at a couple of things and have not demonstrated.