Case study of Net Present Value in mergers and acquisitions

Cardinal Health

The first project is for Micron Technology. The net present value analysis will be used to evaluate this project. The net present value (NPV) technique involves discounting future cash flows to present dollars, to take into account the firm's opportunity cost of capital. As a basic rule, projects that have a positive net present value will add value to the company above and beyond existing operations. All such projects with a positive NPV should be accepted, while projects with a negative NPV should be rejected.

There are a few different approaches to calculating the net present value, but they are all fundamentally the same, based on the principle of discounted cash flow analysis. The first flow is the initial cash outlay. Because this particular cash flow is made today, it is not discounted. This is because payments made today are already in present value format. Future cash flows, however, must be discounted by the discount rate, which in this case is 9%. The formula for NPV is as follows:

Source: Investopedia (2012)

The net present value for each cash flow can be calculated individually, or with the NPV function on Excel. The following example uses both methods:

Year

Flow

-2225000

350000

939000

720000

500000

900000

PV

-2225000

321101

790338

555972

354213

584938

NPV

381561

or

2606561

381561

d

0.09

The final NPV of this project is $381,561. This means that the project adds value to the company. Thus, it is recommended that Micron management accept this project.

Part II: In general, mergers benefit the companies involved when there are synergies between the companies that can translate to added value. The base assumption in a merger is that the price of a company on the stock market reflects its value. Acquiring firms almost always pay a premium for the merger, so they need to see addition, synergistic value from the merger in order to justify it to their shareholders. Not knowing much about chips, it is not easy to tell if the merger would add value to the shareholders of all three corporations. It seems that the merger is to result in a combined entity that can compete against rivals that are larger and better financed. Building size to compete on cost with larger rivals often delivers value for the shareholders of the merged companies.

In order to assess the value of the deal to shareholders, two different things would need to be known. The first is whether there are any technological synergies between these companies. If combining the patents and technology of all the three companies will allow the new entity to produce chips that are either cheaper or superior to those of competitors, then the deal would deliver value. In addition, if the deal would give the combined entity superior market access -- for example access to larger customers -- then the deal would also hold value for the companies. It should also be noted that it is only the acquiring firm that pays a premium. The shareholders of Nanya and Micron will benefit from the initial transaction because a premium will be paid for their shares. The shareholders of Elpida will only benefit of the above-mentioned synergies arise. Elpida shareholders could also benefit if the combined entity has superior access to inputs, at better prices than before.

There are pitfalls, however, to such merger activity. If there are no synergies with the technology, the management or the organizational culture, the acquiring firm could fail to derive value from the transaction. The financing of the deal could also make a difference. Such deals are usually financed either through a debt issue, from cash, from shares or a combination thereof. In this case, there is also the option of financing with help from the Innovation Network Corp of Japan, something that might make the deal cheaper for Elpida than it would be for any other rival. Overall, however, the deal hinges on the firms being able to deliver technological or market synergies in order for the deal to the profitable for Elpida shareholders.

SLP

Cardinal's industry has three major competitors, being Cardinal, AmeriSourceBergen and McKesson. A smaller competitor, Owens & Minor, holds the best potential for a merger. There are a few reasons for this. The first is that this one will get past the anti-trust regulators, and the second is that this deal will increase the size of the company and allow it better distribution and better economies of scale, two synergistic elements that help companies derive value from their merger and acquisition activity. Owens & Minor is a niche player in the industry but has the same slim margins, the same flatlined sales and same low EPS as other firms in the industry. Thus, there are also synergies that can be gained if Cardinal feels that it is better from an operational standpoint than Owens & Minor.

The market cap of Owens & Minor is $1.77 billion according to Yahoo! Finance (2012). As a result, Cardinal could acquire it with cash, if it wanted to do so. However, that approach would be challenging for Cardinal because it would compromise the company's working capital. Cardinal is likely going to need that working capital to fold Owens & Minor into Cardinal. Thus, it will need to find other means of financing the deal than taking cash from the balance sheet. A combination stock and debt deal makes the most sense for Cardinal. This type of deal would rely on treasury stock, and would also rely on taking out a bank loan to provide cash for the cash + stock deal. Cardinal has the capacity to take on additional debt, and the rates are currently very low for commercial paper. Thus, the discount rate for the deal would be quite low. Using a combination of stock and debt will also allow Cardinal to maintain its current capital structure, which is important because too much debt could compromise future cash flows, something that it undesirable in an industry with slow growth and tight margins.