JP Morgan DCF and Merger Model PDF

S T R I C TL Y P R I V A T E AN D C O N F I D E N T I A L
M&A:
DCF
AND
MERGER
ANALYSIS
DECEMBER 2004
M&A - DCF and M&A analysis
[For any pitchbook or presentation including advisory, equity or debt security or loan product or combinations thereof.
NOT for use in fairness/valuation or Commercial Bank presentations.]
This presentation was prepared exclusively for the benefit and internal use of the JPMorgan client to whom it is directly addressed and delivered (including
such clients subsidiaries, the Company) in order to assist the Company in evaluating, on a preliminary basis, the feasibility of a possible transaction or
transactions and does not carry any right of publication or disclosure, in whole or in part, to any other party. This presentation is for discussion purposes
only and is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by JPMorgan. Neither this
presentation nor any of its contents may be disclosed or used for any other purpose without the prior written consent of JPMorgan.
The information in this presentation is based upon any management forecasts supplied to us and reflects prevailing conditions and our views as of this date,
all of which are accordingly subject to change. JPMorgans opinions and estimates constitute JPMorgans judgment and should be regarded as indicative,
preliminary and for illustrative purposes only. In preparing this presentation, we have relied upon and assumed, without independent verification, the
accuracy and completeness of all information available from public sources or which was provided to us by or on behalf of the Company or which was
otherwise reviewed by us. In addition, our analyses are not and do not purport to be appraisals of the assets, stock, or business of the Company or any
other entity. JPMorgan makes no representations as to the actual value which may be received in connection with a transaction nor the legal, tax or
accounting effects of consummating a transaction. Unless expressly contemplated hereby, the information in this presentation does not take into account
AN ALY SI S
the effects of a possible transaction or transactions involving an actual or potential change of control, which may have significant valuation and other
effects.
Notwithstanding anything herein to the contrary, the Company and each of its employees, representatives or other agents may disclose to any and all
persons, without limitation of any kind, the U.S. federal and state income tax treatment and the U.S. federal and state income tax structure of the
transactions contemplated hereby and all materials of any kind (including opinions or other tax analyses) that are provided to the Company relating to such
tax treatment and tax structure insofar as such treatment and/or structure relates to a U.S. federal or state income tax strategy provided to the Company
M E R G E R
by JPMorgan.
JPMorgans policies prohibit employees from offering, directly or indirectly, a favorable research rating or specific price target, or offering to change a
rating or price target, to a subject company as consideration or inducement for the receipt of business or for compensation. JPMorgan also prohibits its
research analysts from being compensated for involvement in investment banking transactions except to the extent that such participation is intended to
benefit investors.
AN D
JPMorgan is a marketing name for investment banking businesses of JPMorgan Chase & Co. and its subsidiaries worldwide. Securities, syndicated loan
arranging, financial advisory and other investment banking activities are performed by a combination of J.P. Morgan Securities Inc., J.P. Morgan plc,
J.P. Morgan Securities Ltd. and the appropriately licensed subsidiaries of JPMorgan Chase & Co. in Asia-Pacific, and lending, derivatives and other
commercial banking activities are performed by JPMorgan Chase Bank, N.A. JPMorgan deal team members may be employees of any of the foregoing
DC F
entities.
This presentation does not constitute a commitment by any JPMorgan entity to underwrite, subscribe for or place any securities or to extend or arrange
credit or to provide any other services.
M&A:
Agenda
Page
Introduction 1
Discounted cash flow analysis 6
Relative value analysis 56

AN ALY SI S
Merger consequences 71
M E R G E R
AN D
DC F
M&A:
1
Valuation methodologies
Valuation
methodologies
Publicly traded
Comparable Discounted Leveraged
comparable
transactions cash flow buyout/recap Other
companies
analysis analysis analysis
analysis
Public Market Private Market Intrinsic value Value to a Liquidation
Valuation Valuation of business financial/LBO analysis
buyer
Value based on Value based on Present value of Break-up analysis
market trading multiples paid for projected free Value based on
Historical trading
multiples of comparable cash flows debt repayment
comparable companies in sale and return on performance
Incorporates both
companies transactions equity investment Expected IPO
short-term and
Applied using Includes control long-term valuation
historical and premium expected Discounted future
prospective performance share price
multiples
I N T R O D U C TI O N
Risk in cash flows EPS impact

Does not include a and capital
control premium structure captured Dividend discount
in discount rate model
2
The valuation process
Determining a final valuation recommendation is a process of triangulation using insight from each
of the relevant valuation methodologies
(1) Discounted (2) Publicly Traded (3) Comparable (4) Leveraged

Cash Flow Comparable Acquisition Buy Out
Analyzes the Companies Transactions Used to determine
present value of Utilizes market Utilizes data from range of potential
a company's free trading multiples M&A transactions value for a
cash flow. from publicly involving similar company based on
traded companies companies. maximum leverage
to derive value. capacity.
3
The valuation summary is the most important slide in a M&A - DCF and M&A analysis
valuation presentation
The science is performing each valuation method correctly, the art is using each
method to develop a valuation recommendation
Price per share
$26.75
$20.00
$15.00
$15.00
$9.75 Implied
$10.00 offer =
$10.25
$8.46
$5.50
$5.00
$5.00 $6.00
$5.00 $4.00
$4.94
$4.00 $3.75 $3.50
$3.00
$0.00
2.5x to 4.0x Mgmt. Case Street Case
52-week 15.0x to 19.0x 19.0x to 25.0x 15.0x to 20.0x LTM revenue
high/low 2005E EBIT 2005E cash 2006E cash of $185.7 12% to 15% 12% to 15%
of $20.6 EPS of $0.16 EPS of $0.25 Discount Rate Discount Rate

EBIT exit mult. EBIT exit mult.
Transaction of 15.0x to 20.0x of 15.0x to 20.0x
Public trading comparables comparables
DCF analysis
4
A primer: firm value vs. equity value
Firm value = Market value of all capital invested in a business(1)

(often referred to as enterprise value or firm value or asset value)
The value of the total enterprise: market value of equity + (total debt +
Capitalized Leases - Cash and Cash equivalents) + Minority Interest +
Preferred Equity
Total debt includes all Long term debt, Current portion of Long term
debt, short term debt and overdrafts
Equity value = Market value of the shareholders equity

(often referred to as offer value)
The market value of a companys equity (shares outstanding x current
stock price)
Assets Liabilities and Shareholders Equity
Net debt, etc.

Enterprise Enterprise
value Value
Equity value
1 The value of debt should be a market value. It may be appropriate to assume book value of debt approximates the market
value as long as the companys credit profile has not changed significantly since the existing debt was issued.
5
Agenda
Page
Introduction 1

AN ALY SI S
M E R G E R
AN D
DC F
M&A:
6
Discounted cash flow analysis as a valuation methodology
Valuation
methodologies
Publicly traded
Comparable Discounted Leveraged
comparable
transactions cash flow buyout/recap Other
companies
analysis analysis analysis
analysis
Public Market Private Market Intrinsic value Value to a Liquidation
Valuation Valuation of business financial/LBO analysis
AN AL Y SI S
buyer
Value based on Value based on Present value of Break-up analysis
market trading multiples paid for projected free Value based on
Historical trading
multiples of comparable cash flows debt repayment
comparable companies in sale and return on performance
Incorporates both
companies transactions equity investment
F L OW
Expected IPO
short-term and
Applied using Includes control long-term valuation
historical and premium expected Discounted future
C A S H
prospective performance share price

multiples
Risk in cash flows EPS impact
D I S C O UN T E D
Does not include a and capital

control premium structure captured Dividend discount
in discount rate model
7
Overview
Free cash
M&Aflow
- DCF and M&A analysis
Terminal value
Overview of DCF analysis

WACC
Other topics
Discounted cash flow analysis is based upon the theory that the value of a
business is the sum of its expected future free cash flows, discounted at an
appropriate rate
DCF analysis is one of the most fundamental and commonly-used valuation

techniques
Widely accepted by bankers, corporations and academics
Corporate clients often use DCF analysis internally
One of several techniques used in M&A transactions; others include:
Comparable companies analysis
AN AL Y SI S
Comparable transaction analysis

Leveraged buyout analysis
Recapitalization analysis, liquidation analysis, etc.
F L OW
DCF analysis may be the only valuation method utilized, particularly if no

comparable publicly-traded companies or precedent transactions are
available
C A S H
D I S C O UN T E D
8
Overview
Free cash
M&Aflow
Terminal value
Overview of DCF analysis

WACC
Other topics
DCF analysis is a forward-looking valuation approach, based on several key

projections and assumptions
Free cash flows
What is the projected operating and financial performance of the
business?
Terminal value
What will be the value of the business at the end of the projection period?
Discount rate
What is the cost of capital (equity and debt) for the business?
AN AL Y SI S
Depending on practical requirements and availability of data, DCF analysis can

be simple or extremely elaborate
There is no single correct method of performing DCF analysis, but certain

F L OW
rules of thumb always apply

Do not simply plug numbers into equations
C A S H
You must apply judgment in determining each assumption

D I S C O UN T E D
9
Overview
Free cash
M&Aflow
Terminal value
The process of DCF analysis

WACC
Other topics
Project the operating results and free cash flows of the business
Projections/FCF
Projections/FCF over the forecast period (typically 10 years, but can be 520 years
depending on the profitability horizon)
Estimate the exit multiple and/or growth rate in perpetuity of the

Terminal
Terminal value
value business at the end of the forecast period
Estimate the companys weighted-average cost of capital to

Discount
Discount rate
rate determine the appropriate discount rate range
AN AL Y SI S
Determine a range of values for the enterprise by discounting the

Present
Present value
value projected free cash flows and terminal value to the present
F L OW
C A S H
Adjust the resulting valuation for all assets and liabilities not
Adjustments
Adjustments accounted for in cash flow projections
D I S C O UN T E D
10
Overview
Free cash
M&Aflow
Terminal value
DCF theory and its application

WACC
Other topics
DCF theory: The value of a productive asset is equal to the present value of all
expected future cash flows that can be removed without affecting the assets value
(including an estimated terminal value), discounted using an appropriate weighted-
average cost of capital
The cash-flow streams that are discounted include

Unlevered or levered free cash flows over the projection period
Terminal value at the end of the projection period
These future free cash flows are discounted to the present at a discount rate
commensurate with their risk
AN AL Y SI S
If you are using unlevered free cash flows (our preferred approach), the
appropriate discount rate is the weighted-average cost of capital for debt and
equity capital invested in the enterprise in optimal/targeted proportions
If you are using levered free cash flows, the appropriate discount rate is simply
F L OW
the cost of equity capital (often referred to as flows to shareholders or dividend

discount model)
C A S H
D I S C O UN T E D
11
Overview
Free cash
M&Aflow
Terminal value
The two basic DCF approaches must not be confused

WACC
Other topics
DCF of unlevered cash flows (the focus of these materials)

Projected income and cash-flow streams are free of the effects of debt, net of
excess cash
Present value obtained is the value of assets, assuming no debt or excess cash
(firm value or enterprise value)
Debt associated with the business is subtracted (and excess cash balances are
added) to determine the present value of the equity (equity value)
Cash flows are discounted at the weighted-average cost of capital
DCF of levered cash flows (most common in valuation of financial institutions)

AN AL Y SI S
Projected income and cash-flow streams are after interest expense and net of any
interest income
Present value obtained is the value of equity
Cash flows are discounted at the cost of equity
F L OW
C A S H
D I S C O UN T E D
12
Overview
Free cash
M&Aflow
Terminal value
Other considerations
WACC
Other topics
Reliability of projections
DCF results are generally more sensitive to cash flows (and terminal value) than to
small changes in the discount rate. Care should be taken that assumptions driving
cash flows are reasonable. Generally, we try to use estimates provided by analysts
from reputable Wall Street firms if the client has not provided projections
Sensitivity analysis
Remember that DCF valuations are based on assumptions and are therefore
approximate. Use several scenarios to bound the targets value. Generally, the best
variables to sensitize are sales, EBITDA margin, WACC and exit multiples or
AN AL Y SI S
perpetuity growth rate

F L OW
C A S H
D I S C O UN T E D
Hence, always present a range for the valuation!
13
Overview
Free cash
M&Aflow
Terminal value
Always remember
WACC
Other topics
Three key drivers

Projections and incremental cash flows (unlevered free cash flow)
Residual value at end of the projection period (terminal value)
Weighted-average cost of capital (discount rate)
Avoid pitfalls
Validate and test projection assumptions
Determine appropriate cash flow stream
Thoughtfully consider terminal value methodology
Use appropriate cost of capital approach
Carefully consider all variables in calculation of the discount rate
AN AL Y SI S
Sensitize appropriately (base projection variables, synergies, discount rates,

terminal values, etc.)
Footnote assumptions in detail
F L OW
Think about other value enhancers and detractors

C A S H
D I S C O UN T E D
Always double-check with a calculator!
14
Overview
The first step in DCF analysis is projection of unlevered Free cash

M&Aflow
Terminal value
free cash flows

WACC
Other topics
Calculation of unlevered free cash flow begins with financial projections

Comprehensive projections (i.e., fully-integrated income statement, balance
sheet and statement of cash flows) typically provide all the necessary elements
Quality of DCF analysis is a function of the quality of projections

Often required to fill in the gaps
Confirm and validate key assumptions underlying projections
Sensitize variables that drive projections
Sources of projections include

Target companys management
Acquiring companys management
AN AL Y SI S
Research analysts
Bankers
F L OW
C A S H
D I S C O UN T E D
15
Overview
Free cash
M&Aflow
Terminal value
Projecting financial statements

WACC
Other topics
Ideally projections should go out as far into the future as can reasonably be
estimated to reduce dependence on the terminal value
Most important assumptions

Sales growth: Use divisional, product-line or location-by-location build-up or
simple growth assumptions
Operating margins: Evaluate improvement over time, competitive factors, SG&A
costs
Synergies: Estimate dollars in Year 1 and evaluate margin impact over time
Depreciation: Should conform with historic and projected capex
Capital expenditures: Consider both maintenance and expansion capex
AN AL Y SI S
Changes in net working capital: Should correspond to historical patterns and grow
as the business grows
Should show historical financial performance and sanity check projections against
F L OW
past results. Be prepared to articulate why projections may or may not be similar to
past results (e.g. reasons behind margin improvements, increased sales growth, etc.)
C A S H
Analyze projections for consistency

Sales increases usually require working capital increases
D I S C O UN T E D
CAPEX and depreciation should converge over time
16
Overview
Free cash flow is the cash that remains for creditors and Free cash
M&Aflow
Terminal value
owners after taxes and reinvestment

WACC
Other topics
Unlevered free cash flows can be forecast from a firms financial projections, even if
those projections include the effects of debt
To do this, simply start your calculation with EBIT (earnings before interest and
taxes)
EBIT (from the income statement)
Plus: Non-tax-deductible goodwill amortization
Less: Taxes (at the marginal tax rate)
Equals: Tax-effected EBITA

Plus: Deferred taxes1
Plus: Depreciation and any tax-deductible amortization
AN AL Y SI S
Less: Capital expenditures

Plus/(less): Decrease/(increase) in net working investment
F L OW
Equals: Unlevered free cash flow

C A S H
D I S C O UN T E D
1 Although beyond the scope of our current discussions, you should only include actual cash taxes paid in the DCF. Depending on the firm and industry, you may want to adjust
for the non-cash (or deferred) portion of a firms tax provision. The tax footnote in the financial statements will give you a good idea of whether this is a meaningful issue
for your analysis
17
Overview
Free cash
M&Aflow
Terminal value
Example: Calculating unlevered free cash flows

WACC
Other topics
Stand-alone
Stand-alone DCF
DCF analysis
analysis of
of Company
Company X
X
$ millions
$ millions
Fiscal year ending December 31,
2001 2002 2003 2004P 2005P 2006P 2007P 2008P
Net sales $400.0 $440.0 $484.0 $532.4 $585.6 $644.2 $708.6 $779.5
EBITDA 80.0 88.0 96.8 106.5 117.1 128.8 141.7 155.9
Less: Depreciation 12.0 13.2 14.5 16.0 17.6 19.3 21.3 23.4
EBITA 68.0 74.8 82.3 90.5 99.6 109.5 120.5 132.5
Less: Taxes at marginal rate 27.2 29.9 32.9 36.2 39.8 43.8 48.2 53.0
Tax-effected EBITA $40.8 $44.9 $49.4 $54.3 $59.7 $65.7 $72.3 $79.5
Plus: Depreciation 16.0 17.6 19.3 21.3 23.4
Plus: Deferred taxes
Less: Capital expenditures 20.0 22.0 24.2 26.6 29.3
Less: Incr./(decr.) in working capital 10.0 8.5 7.0 5.5 4.0
AN AL Y SI S
Unlevered free cash flow 40.3 46.8 53.8 61.4 69.6

Adjustment for deal date (40.3)
Unlevered FCF to acquirer $0.0 $46.8 $53.8 $61.4 $69.6
F L OW
Key assumptions:
Deal/valuation date = 12/31/04
Marginal tax rate = 40%
C A S H
D I S C O UN T E D
18
Overview
Valuing the incremental effects of changes in projected Free cash

M&Aflow
Terminal value
operating results
WACC
Other topics
In performing DCF analysis, we often need to determine the incremental impact on

value of certain events or adjustments to the projections, including:
Synergies achievable through the M&A transaction
Revenue
Cost
Capital expenditures
Expansion plans
Cost reductions
Change in sales growth
Margin improvements
AN AL Y SI S
These incremental effects can be valued by discounting them independently (net of

taxes) or by adjusting the DCF model and simply measuring the incremental impact
F L OW
C A S H
D I S C O UN T E D
19
Overview
Once unlevered free cash flows are calculated, they must Free cash
M&Aflow
Terminal value
be discounted to the present

WACC
Other topics
The standard present value calculation takes into account the cost of capital by attributing
greater value to cash flows generated earlier in the projection period than later cash flows
FCF1 FCF2 FCF3 FCFn

Present value = + + + +
(1+r)1 (1+r)2 (1+r)3 ... (1+r)n
Since most businesses do not generate all of their free cash flows on the last day of the
year, but rather more-or-less continuously during the year, DCF analyses often use the so-
called mid-year convention, which takes into account the fact that free cash flows occur
during the year
AN AL Y SI S
FCF1 FCF2 FCF3 FCFn

JPMorgan
JPMorgan Present value = + + + +
standard
standard (1+r)0.5 (1+r)1.5 (1+r)2.5 ... (1+r)n-0.5
F L OW
C A S H
This approach moves each cash flow from the end of the applicable period to the middle of
the same period (i.e., cash flows are moved closer to the present)
D I S C O UN T E D
20
It is important to differentiate between the transaction M&A - DCF and M&A analysis
date and the mid-year convention
Transaction
Transaction date:
date: 01/01
01/01
Year 0 0.5 1 1.5 2 2.5 3 3.5
First cash flow, Second cash flow, Third cash flow,

mid-year 1 mid-year 2 mid-year 3
CF1 CF2 CF3
Discounting = + + + .
(1+r)0.5 (1+r)1.5 (1+r)2.5
Transaction
Transaction date:
date: 06/30
06/30
Period 1 CF to buyer
AN AL Y SI S
Year 0 0.5 0.75 1 1.5 2 2.5 3 3.5

F L OW
First cash flow, Second cash flow, Third cash flow,

C A S H
mid-period 1 mid-year 2 mid-year 3
CF1 CF2 CF3

D I S C O UN T E D
(0.75-0.5) (1.5-0.5) (2.5-0.5)
(1+r) (1+r) (1+r)
21
Practice exercise
Transaction
Transaction date:
date: 09/30
09/30
Period 1 CF
to buyer
Year 0 0.5 0.75 1 1.5 2 2.5 3 3.5
1st flow, 2nd cash flow, 3rd cash flow,

mid-period 1 mid-year 2 mid-year 3
CF1 CF2 CF3

AN AL Y SI S
(1+r)(0.875-0.75) (1+r)(1.5-0.75) (1+r)(2.5-0.75)

F L OW
C A S H
D I S C O UN T E D
22
Overview
Free cash
M&Aflow
Terminal value
Example: Discounting free cash flows

WACC
Other topics
Stand-alone
Stand-alone DCF
DCF analysis
analysis of
of Company
Company X
X
$ millions
$ millions
2001 2002 2003 2004P 2005P 2006P 2007P 2008P
Net sales $400.0 $440.0 $484.0 $532.4 $585.6 $644.2 $708.6 $779.5
EBITDA 80.0 88.0 96.8 106.5 117.1 128.8 141.7 155.9
EBITA 68.0 74.8 82.3 90.5 99.6 109.5 120.5 132.5
AN AL Y SI S

Memo: Discounting factor 0.0 0.5 1.5 2.5 3.5

F L OW
Discounted value of unlevered FCF $0.0 $44.6 $46.7 $48.4 $49.9

Discounted value of FCF 2005P2008P 189.6
C A S H
$46.8 $53.8 $61.4 $69.6

Formula $189.6 = + + +
(1+.10)0.5 (1+.10)1.5 (1+.10)2.5 (1+.10)3.5
D I S C O UN T E D
Key assumptions:
Discount rate = 10%
23
Overview
Terminal value can account for a significant portion of Free cash

M&Aflow
Terminal value
value in a DCF analysis

WACC
Other topics
Terminal value represents the businesss value at the end of the projection period;
i.e., the portion of the companys total value attributable to cash flows expected
after the projection period
Terminal value is typically based on some measure of the performance of the

business in the terminal year of the projection (which should depict the business
operating in a steady-state/normalized manner)
Terminal (or Exit) multiple method
Assumes that the business is valued/sold at the end of the terminal year at a
multiple of some financial metric (typically EBITDA)
Growth in perpetuity method
Assumes that the business is held in perpetuity and that free cash flows
AN AL Y SI S
continue to grow at an assumed rate

A terminal multiple will have an implied growth rate and vice versa. It is
essential to review the implied multiple/growth rate for sanity check purposes
F L OW
Once calculated, the terminal value is discounted back to the appropriate date using
the relevant rate
C A S H
Attempt to reduce dependence on the terminal value

What is appropriate projection time frame?
D I S C O UN T E D
What percentage of total value comes from the terminal value?
24
Overview
Free cash
M&Aflow
Terminal value
Terminal multiple method

WACC
Other topics
This method assumes that the business will be valued at the end of the last year of
the projected period
The terminal value is generally determined as a multiple of EBIT, EBITDA or

EBITDAR; this value is then discounted to the present, as were the interim free cash
flows
The terminal value should be an asset (firm) value; remember that not all
multiples produce an asset value
Note that in the exit multiple method terminal value is always assumed to be
calculated at the end of the final projected year, irrespective of whether you are
using the mid-year convention
AN AL Y SI S
Should the terminal multiple be an LTM multiple or a forward multiple?

If the terminal value is based on the last year of your projection then the multiple
should be based on an LTM multiple (most common)
There are circumstances where you will project an additional year of EBITDA and
F L OW
apply a forward multiple

C A S H
D I S C O UN T E D
25
Overview
Free cash
M&Aflow
Terminal value
Most common error: The final year is not normalized

WACC
Other topics
Consider adding a year to the projections which represents a normalized year
A steady-state, long-term industry multiple should be used rather than a current

multiple, which can be distorted by contemporaneous industry or economic factors
Treat the terminal value cash flow as a separate, critical forecast

Growth rate
Consistent with long-term economic assumptions
Reinvestment rate
Net working investment consistent with projected growth
Capital expenditures needed to fuel estimated growth
Depreciation consistent with capital expenditures
AN AL Y SI S
Margins
Adjusted to reflect long-term estimated profitability
Normalized tax rate
F L OW
C A S H
D I S C O UN T E D
26
Overview
Free cash
M&Aflow
Terminal value
Example: Terminal multiple method

WACC
Other topics
Stand-alone
Stand-alone DCF
DCF analysis
analysis of
of Company
Company X
X
$
$ millions
millions
2001 2001 2003 2004P 2005P 2006P 2007P 2008P
Net sales $400.0 $440.0 $484.0 $532.4 $585.6 $644.2 $708.6 $779.5
EBITDA 80.0 88.0 96.8 106.5 117.1 128.8 141.7 155.9
EBITA 68.0 74.8 82.3 90.5 99.6 109.5 120.5 132.5
AN AL Y SI S

F L OW
EBITDA in 2008P $155.9

Exit multiple 7.0x
Firm value at exit 1,091.3
Discounted terminal value 745.4
C A S H
Total present value to acquirer $934.9

D I S C O UN T E D
Key assumptions:
Deal/valuation date = 12/31/04 ($155.9 * 7.0x)
Marginal tax rate = 40% Formula $745.4 =
Discount rate = 10%
Exit multiple of EBITDA = 7.0x (1+.10)4
27
Overview
Free cash
M&Aflow
Terminal value
Example: Terminal multiple method (contd)

WACC
Other topics
Stand-alone
Stand-alone DCF
DCF analysis
analysis of
of Company
Company X
X
$ millions, except per share data
$ millions, except per share data
A + B = C
Discounted Discounted terminal value Firm value
FCF at 2008P EBITDA multiple of at 2008P EBITDA multiple of
Discount rate 20052008 6.0x 7.0x 8.0x 6.0x 7.0x 8.0x
8% $196.8 $687.5 $802.1 $916.7 $884.4 $999.0 $1,113.6
9% 193.1 662.6 773.1 883.5 855.8 966.2 1,076.7
10% 189.6 638.9 745.4 851.8 828.4 934.9 1,041.4
11% 186.1 616.2 718.9 821.6 802.3 904.9 1,007.6
12% 182.7 594.5 693.5 792.6 777.2 876.3 975.3
AN AL Y SI S
D = E
Equity value Equity value per share1
Net debt at 2008P EBITDA multiple of at 2008P EBITDA multiple of
Discount rate 12/31/04 6.0x 7.0x 8.0x 6.0x 7.0x 8.0x
F L OW
8% $100.0 $784.4 $899.0 $1,013.6 $19.17 $21.97 $24.77

9% 100.0 755.8 866.2 976.7 $18.47 $21.17 $23.87
10% 100.0 728.4 834.9 941.4 $17.80 $20.41 $23.01
C A S H
11% 100.0 702.3 804.9 907.6 $17.16 $19.67 $22.18

12% 100.0 677.2 776.3 875.3 $16.55 $18.97 $21.39
D I S C O UN T E D
Note: DCF value as of 12/31/01 based on mid-year convention

1 Based on 40.91 million diluted shares outstanding
28
Overview
Free cash
M&Aflow
Terminal value
Growth in perpetuity method

WACC
Other topics
This method assumes that the business will be owned in perpetuity and that the
business will grow at approximately the long-term macroeconomic growth rate
Few businesses can be expected to have cash flows that truly grow forever; be
conservative when estimating growth rates in perpetuity
Take free cash flow in the last year of the projection period, n, and grow it one
more year to n+1;1 this free cash flow is then capitalized at a rate equal to the
discount rate minus the growth rate in perpetuity
To ensure that the terminal year is normalized, JPMorgan models are set up to
project one year past the projection year and allow for normalizing adjustments;
this FCFn+1 is then discounted by the perpetuity formula
AN AL Y SI S
Academic
Academic formula
formula JPM
JPM recommended
recommended method
method
Terminal value = (FCFn * (1 + g))/(WACC g) Terminal value = (FCFn+1)/(WACC g)
where FCFn = FCF in final projected period where FCFn+1 = FCF in year after projections
F L OW
g = growth rate in perpetuity g = growth rate in perpetuity

WACC = weighted-avg. cost of capital WACC = weighted-avg. cost of capital
C A S H
PV of terminal value = terminal value/(1+WACC)n-0.5 PV of terminal value = terminal value/(1+WACC)n-0.5

D I S C O UN T E D
1 This step is taken because the perpetuity growth formula is based on the principle that the terminal value of a business is the value of its next cash flow, divided by the
difference between the discount rate and a perpetual growth rate
29
Overview
Free cash
M&Aflow
Terminal value
Growth in perpetuity method (contd)

WACC
Other topics
Note that when using the mid-year convention, terminal value is discounted as if
cash flows occur in the middle of the final projection period
Here the growth-in-perpetuity method differs from the exit-multiple method
Typical adjustments to normalize free cash flow in Year n include revising the
relationship between revenues, EBIT and capital spending, which in turn affects
CAPEX and depreciation
Working capital may also need to be adjusted
Often CAPEX and depreciation are assumed to be equal
AN AL Y SI S
F L OW
C A S H
D I S C O UN T E D
30
Overview
Free cash
M&Aflow
Terminal value
Example: Growth in perpetuity method

WACC
Other topics
Stand-alone
Stand-alone DCF
DCF analysis
analysis of
of Company
Company X
X
$ millions
$ millions
2001 2002 2003 2004P 2005P 2006P 2007P 2008P
Net sales $400.0 $440.0 $484.0 $532.4 $585.6 $644.2 $708.6 $779.5
EBITDA 80.0 88.0 96.8 106.5 117.1 128.8 141.7 155.9
EBITA 68.0 74.8 82.3 90.5 99.6 109.5 120.5 132.5
AN AL Y SI S


F L OW

C A S H
PV of Terminal Value 733.7

Total present value to acquirer $923.3
D I S C O UN T E D
Key assumptions:
Discount rate = 10% $69.6 * (1 + .03)
Perpetuity growth rate = 3% Formula $733.6 =
(.10 - .03)*(1+.10)3.5
31
Overview
Free cash
M&Aflow
Terminal value
Example: Growth in perpetuity method (contd)

WACC
Other topics
Stand-alone
Stand-alone DCF
DCF analysis
analysis of
of Company
Company X
X
$
$ millions,
millions, except
except per
per share
share data
data
A + B = C
Discounted Discounted terminal value Firm value

FCF at perpetuity growth rate of at perpetuity growth rate of
Discount rate 20052008 2.5% 3.0% 3.5% 2.5% 3.0% 3.5%
8% $196.8 $991.0 $1,095.4 $1,223.0 $1,187.8 $1,292.2 $1,419.8
9% 193.1 811.9 883.8 968.9 1,005.0 1,077.0 1,162.0
10% 189.6 681.5 733.7 794.0 871.1 923.3 983.6
11% 186.1 582.6 622.0 666.7 768.7 808.1 852.8
12% 182.7 505.1 535.8 570.1 687.9 718.5 752.8
D = E
AN AL Y SI S
Equity value Equity value per share1

Net debt at perpetuity growth rate of at perpetuity growth rate of
Discount rate 12/31/04 2.5% 3.0% 3.5% 2.5% 3.0% 3.5%
8% $100.0 $1,087.8 $1,192.2 $1,319.8 $26.59 $29.14 $32.26
9% 100.0 905.0 977.0 1,062.0 $22.12 $23.88 $25.96
10% 100.0 771.1 823.3 883.6 $18.84 $20.12 $21.59
F L OW
11% 100.0 668.7 708.1 752.8 $16.34 $17.31 $18.40

12% 100.0 587.9 618.5 652.8 $14.37 $15.12 $15.95
C A S H
D I S C O UN T E D

32
Overview
Terminal multiples and perpetuity growth rates are often Free cash
M&Aflow
Terminal value
considered side-by-side
WACC
Other topics
Assumptions regarding exit multiples are often checked for reasonableness by calculating the
growth rates in perpetuity that they imply (and vice versa)
To go from the exit-multiple approach to an implied perpetuity growth rate:
g = [(WACC*terminal value) / (1+WACC)0.5 - FCFn] / [FCFn + (terminal value / (1 + WACC)0.5)]
To go from the growth-in-perpetuity approach to an implied exit multiple:
multiple = [FCFn * (1 + g)(1 + WACC)0.5] / [EBITDAn * (WACC - g)]
These formulas adjust for the different approaches to discounting terminal value when using
the mid-year convention
AN AL Y SI S
F L OW
C A S H
D I S C O UN T E D
33
Overview
Free cash
M&Aflow
Terminal value
Terminal multiple method and implied growth rates

WACC
Other topics
Standalone
Standalone Company
Company X
X DCF
DCF analysis
analysis
$
$ millions
millions
A + B = C
Discounted Discounted terminal value Firm value Terminal value as percent
Discount FCF at 2008P EBITDA multiple of at 2008P EBITDA multiple of of total firm value
rate 20052008 6.0x 7.0x 8.0x 6.0x 7.0x 8.0x 6.0x 7.0x 8.0x
8% $196.8 $687.5 $802.1 $916.7 $884.4 $999.0 $1,113.6 78% 80% 82%
9% 193.1 662.6 773.1 883.5 855.8 966.2 1,076.7 77% 80% 82%
10% 189.6 638.9 745.4 851.8 828.4 934.9 1,041.4 77% 80% 82%
11% 186.1 616.2 718.9 821.6 802.3 904.9 1,007.6 77% 79% 82%
12% 182.7 594.5 693.5 792.6 777.2 876.3 975.3 76% 79% 81%
D = E
Equity value Equity value per share1 Implied perpetuity growth rate
AN AL Y SI S
Discount Net debt at 2008P EBITDA multiple of at 2008P EBITDA multiple of at 2008P EBITDA multiple of
rate 12/31/04 6.0x 7.0x 8.0x 6.0x 7.0x 8.0x 6.0x 7.0x 8.0x
8% $100.0 $784.4 $899.0 $1,013.6 $19.17 $21.97 $24.77 0.2% 1.3% 2.1%
9% 100.0 755.8 866.2 976.7 $18.47 $21.17 $23.87 1.1% 2.2% 3.0%
10% 100.0 728.4 834.9 941.4 $17.80 $20.41 $23.01 2.0% 3.1% 3.9%
F L OW
11% 100.0 702.3 804.9 907.6 $17.16 $19.67 $22.18 2.9% 4.0% 4.8%
12% 100.0 677.2 776.3 875.3 $16.55 $18.97 $21.39 3.8% 4.9% 5.8%
C A S H
At a 9% discount rate and an 8.0x exit multiple the price

is $23.87 and the implied terminal growth rate is 3.0%
D I S C O UN T E D

34
Overview
Free cash
M&Aflow
Terminal value
Perpetuity growth rate and implied terminal multiples

WACC
Other topics
Standalone
Standalone Company
Company X
X DCF
DCF analysis
analysis
$
$ millions
millions
A + B = C
Discounted Discounted terminal value Firm value Terminal value as percent
Discount FCF at perpetuity growth rate of at perpetuity growth rate of of total firm value
rate 20052008 2.5% 3.0% 3.5% 2.5% 3.0% 3.5% 2.5% 3.0% 3.5%
8% $196.8 $991.0 $1,095.4 $1,223.0 $1,187.8 $1,292.2 $1,419.8 83% 85% 86%
9% 193.1 811.9 883.8 968.9 1,005.0 1,077.0 1,162.0 81% 82% 83%
10% 189.6 681.5 733.7 794.0 871.1 923.3 983.6 78% 79% 81%
11% 186.1 582.6 622.0 666.7 768.7 808.1 852.8 76% 77% 78%
12% 182.7 505.1 535.8 570.1 687.9 718.5 752.8 73% 75% 76%
D = E
Equity value Equity value per share1 Implied EBITDA exit multiple
AN AL Y SI S
Discount Net debt at perpetuity growth rate of at perpetuity growth rate of at perpetuity growth rate of
rate 12/31/04 2.5% 3.0% 3.5% 2.5% 3.0% 3.5% 2.5% 3.0% 3.5%
8% $100.0 $1,087.8 $1,192.2 $1,319.8 $26.59 $29.14 $32.26 8.6x 9.6x 10.7x
9% 100.0 905.0 977.0 1,062.0 $22.12 $23.88 $25.96 7.4 8.0 8.8
10% 100.0 771.1 823.3 883.6 $18.84 $20.12 $21.59 6.4 6.9 7.5
F L OW
11% 100.0 668.7 708.1 752.8 $16.34 $17.31 $18.40 5.7 6.1 6.5
12% 100.0 587.9 618.5 652.8 $14.37 $15.12 $15.95 5.1 5.4 5.8
C A S H
At a 9% discount rate and a terminal growth rate of 3.0%,

the price is $23.88 and the implied exit multiple is 8.0x
D I S C O UN T E D

35
Overview
Choosing the discount rate is a critical step in Free cash

M&Aflow
Terminal value
DCF analysis
WACC
Other topics
The discount rate represents the required rate of return given the risks inherent in
the business, its industry, and thus the uncertainty regarding its future cash flows, as
well as its optimal capital structure
Typically the weighted average cost of capital (WACC) will be used as a foundation
for setting the discount rate
The WACC is always forward-looking and is predicted based on the expectations of

an investment's future performance; an investor contributes capital with the
expectation that the riskiness of cash flows will be offset by an appropriate return
The WACC is typically estimated by studying capital costs for existing investment
opportunities that are similar in nature and risk to the one being analyzed
AN AL Y SI S
The WACC is related to the risk of the investment, not the risk or creditworthiness of
the investor
F L OW
C A S H
D I S C O UN T E D
1 In valuing a company, always use the riskiness of its cash flows or comparable companies in estimating a weighted average cost of capital. Never use the acquirers cost
capital unless, by some chance, it is engaged in an extremely similar line of business. However, if a business is small relative to an acquirors, sometimes ti may be
appropriate to consider the use of the acquirors WACC in performing the valuation. The additional value created by using the acquirors WACC can be viewed as a synergy to
the acquiror in the context of the transaction.
36
Overview
JPMorgan estimates the cost of equity using the capital Free cash
M&Aflow
Terminal value
asset pricing model

WACC
Other topics
The Capital Asset Pricing Model (CAPM) classifies risk as systematic and
unsystematic. Systematic risk is unavoidable. Unsystematic risk is that portion of
risk that can be diversified away, and thus will not be paid for by investors
The CAPM concludes that the assumption of systematic risk is rewarded with a risk
premium, which is an expected return above and beyond the risk-free rate. The size
of the risk premium is linearly proportional to the amount of risk taken. Therefore,
the CAPM defines the cost of equity as equaling the risk-free rate plus the amount of
systematic risk an investor assumes
The CAPM formula follows:
Cost of equity = Risk-free rate + (beta * market risk premium)

AN AL Y SI S
re = rf + * (rm - rf)
Where
re = the required market return on the equity of the company
F L OW
rf = the risk-free rate

rm = the return on the market
= the companys projected (leveraged) beta
C A S H
There is also an error term in the CAPM formula, but this is usually omitted
D I S C O UN T E D
37
Overview
Free cash
M&Aflow
Terminal value
The cost of equity is the major component of the WACC

WACC
Other topics
The cost of equity reflects the long-term return expected by the market (dividend
yield plus share appreciation)
Risk-free rate based on the 10 year bond yield
Incorporates the undiversifiable risk of an investment (beta)
Equity risk premium reflects expectations of todays market
The market risk premium (rm - rf; i.e., the spread of market return over the risk-free
rate) is periodically estimated by M&A research based on analysis of historical data
AN AL Y SI S
Cost of equity = Risk free rate + Beta x Equity risk premium
Long-term return on Long-term risk-free Adjustment for Appropriate extra

equity investment in rate of return correlation to return above risk free
= + x
F L OW
todays market (beta=0) stock market rate

returns
C A S H
= 10-year bond yield + Predicted betas x Estimated using

(annual average) various techniques
D I S C O UN T E D
For market average = 4.97% + 1.00 x 5.00%
= 9.97%
38
Overview
Free cash
M&Aflow
Terminal value
JPMorgan estimates the equity risk premium at 5.0%

WACC
Other topics
Equity risk premiums is estimated based on expected returns and recent historical returns
Equity
Equity premiums
premiums Equity
Equity returns
returns less
less 10-year
10-year bond
bond yield
yield
Rolling
Rolling average
average over
over 10-year
10-year bond
bond Arithmetic average
Arithmetic average
30 years ending Equity risk premium (%)
14%
Rolling 30 years Rolling 40 years Rolling 50 years 1994 2.7
1995 3.4
1996 4.4
12%
1997 4.7
1998 5.2
1999 6.2
10% 2000 5.8
2001 5.0
AN AL Y SI S
8%
6%
F L OW
4%
C A S H
2%
D I S C O UN T E D
1955 1959 1963 1968 1972 1976 1980 1984 1988 1993 1997 2001
39
Overview
Free cash
M&Aflow
Terminal value
Beta
WACC
Other topics
Beta provides a method to estimate an asset's systematic (non-diversifiable) risk
Beta equals the covariance between expected returns on the asset and on the stock
market, divided by the variance of expected returns on the stock market
A company whose equity has a beta of 1.0 is as risky as the overall stock market
and should therefore be expected to provide returns to investors that rise and fall as
fast as the stock market; a company with an equity beta of 2.0 should see returns on
its equity rise twice as fast or drop twice as fast as the overall market
Returning to our CAPM formula, the beta determines how much of the market risk
premium will be added to or subtracted from the risk-free rate
AN AL Y SI S
Since the cost of capital is an expected value, the beta value should be an expected
value as well
Although the CAPM analysis, including the use of beta, is the overwhelming favorite
for DCF analysis, other capital asset pricing models exist, such as multi-factor
F L OW
models like the Arbitrage Pricing Theory

C A S H
D I S C O UN T E D
40
Overview
JPMorgan uses predicted betas to calculate the cost of Free cash

M&Aflow
Terminal value
equity
WACC
Other topics
Predicted betas are constructed to adjust for many risk factors, incorporating firms earnings
volatility, size, industry exposure, and leverage
Predicted betas are more consistent and less volatile than historical betas
Historical betas only measure the past relationship between a firms return and market returns
and are often distorted
Projected betas can be obtained from Barra or an online database (e.g., IDD)
Barra predicted betas can be found through the Investment Bank Home Web page1
Note that Bloomberg betas are based on historic prices and are therefore not forward-looking
Impute unlevered beta for private company from public comparables
Distribution
Distribution of
of predicted
predicted and
and historical
historical betas
betas for
for 5,600
5,600 publicly-traded
publicly-traded companies
companies
AN AL Y SI S
800 Historical Beta Predicted Beta 800 Predicted betas

Supermarkets
0.78
600 600 Cellular
# of companies
# of companies
Food 1.62
400 400 0.52
F L OW
Internet
200 200 Utilities 2.09
0.43
0 0
C A S H
(1.5) (1.0) (0.5) 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 (0.5) 0.2 1.0 1.9 2.6
Beta Beta
D I S C O UN T E D
41
Delevering and relevering beta
Recalling our previous discussion regarding the difference between asset values and
equity values, a similar argument exists for betas. The predicted equity beta, i.e.,
the observed beta, included the effects of leverage. In the course of performing a
variance analysis, which looks at different target capitalizations, the equity beta
must be delevered to get an asset, or unlevered, beta. This asset beta is then
used in the CAPM formula to determine the appropriate cost of capital for various
debt levels
The formula follows:
U= L/[1 = ((1 T) * (Debt/Equity))]
Where:
AN AL Y SI S
U = unlevered (asset) beta

BL = leveraged beta
T = marginal tax rate
F L OW
To relever the beta at a target capital structure:

C A S H
L= U*[1 + ((1 T) * (Debt/Equity))]

D I S C O UN T E D
42
Delevering and relevering beta (contd)
Note that JPMorgan M&A sometimes uses a factor, tau, in place of the marginal tax
rate, T
Tau, currently equal to 0.26, represents the average blended benefit a
shareholder gets from a company borrowing (reflects many factors)
The value of Tau is derived by researchers using complicated statistical analyses
Although the delevering/relevering methodology is standard for WACC analyses, the

formula does not produce a highly accurate result
Remember the fundamentals: the market charges more for equity of companies that
are financially risky
Exercise
AN AL Y SI S
1. Levered Beta = 1.25, T = 40%, D/E= 0.75; What is the Beta Unlevered?
2. Find the levered Beta at a D/E = 1.0
F L OW
C A S H
D I S C O UN T E D
43
Overview
Free cash
M&Aflow
Terminal value
The cost of a firms equity should be adjusted for size

WACC
Other topics
Size
Size premium
premium byby market
market cap
cap
Based
Based on historical returns
on historical returns analysis
analysis
Investors typically expect higher returns Market cap ($mm)
when investing in smaller companies 5.2%
Increased risk 3.1%

2.5%
Lower liquidity 1.9% 1.7%
1.4% 1.1%
0.8%
Betas vary very little by size 0.0%
$0 $100 $250 $500 $700- $1,000 $1,500 $2,500

$5,000+
Historical equity returns suggest higher 100 250 500 700 1,000 1,500 2,500 5,000
return required by investors in smaller

companies Size
Size premium
premium by
by market
market cap
cap
Based
Based on PE/growth (PEG)
on PE/growth (PEG)
P/E growth ratios (PEG) tend to decline with
AN AL Y SI S
Market cap ($mm)

size 2.2%
1.6%
Empirical data combined with judgement
1.1%
should be applied when estimating the cost 0.8%
F L OW
of equity for smaller firms

0.0%
C A S H
$100500 $5001,000 $1,0002,500 $2,5005,000 $5,000+

D I S C O UN T E D
44
Overview
JPMorgan uses the long-term cost of debt in Free cash

M&Aflow
Terminal value
estimating WACC
WACC
Other topics
The long-term cost of debt is used because the cost of capital is normally applied to
long-term cash flows
Using the long-term cost of debt removes any refinancing costs/risks from the
valuation analysis
To the extent a company can fund its investments at a lower cost of debt (with
the same risk), this value should be attributed to the finance staff
JPMorgan uses the companys normalized cash tax rate

AN AL Y SI S
F L OW
C A S H
D I S C O UN T E D
45
Overview
The cost of equity and debt are blended together based Free cash
M&Aflow
Terminal value
on a target capital structure

WACC
Other topics
The target capital structure reflects the companys rating objective

Firms generally try to minimize the cost of capital through the appropriate use of leverage
The percentage weighting of debt and equity is usually based on the market value of a firms equity and debt
position
Most firms are at their target capital structure
Adjustments should be made for seasonal or cyclical swings, as well as for firms moving toward a target
Using a weighted average cost of capital assumes that all investments are funded with the same mix of equity
and debt as the target capital structure
WACC
WACC formula
formula
WACC = rd * [D *(1-T)] + re * E Where: T = Marginal tax rate
D+E D+E E = Market value of equity re = Return on equity
AN AL Y SI S
D = Market value of debt rd = Return on debt
Illustrative
Illustrative SYSCO
SYSCO weighted
weighted average
average cost
cost of
of capital
capital calculation
calculation
Cost of equity Cost of debt
F L OW
Cost of capital Cost of debt 6.25%

10-year T-bond (Avg) 4.97%
(-) Tax shield1 2.19%
C A S H
Market risk premium 5.00%

(x) Beta (current predicted) 0.62 Target capital structure After-tax cost of debt 4.06%
Adjusted market premium 3.10% (Assumes current = optimal)
Debt/total capital2 = 6.1%
D I S C O UN T E D
Cost of equity = 8.07%
Nominal WACC = 7. 82%

1 Assumes 35% marginal tax rate
2 Total capital = debt + market value of equity
46
Example: Calculating WACC based on M&A - DCF and M&A analysis
comparable companies
Target
Target WACC
WACC analysis
analysis as
as of
of 1/1/01
1/1/01
Macroeconomic
Macroeconomic assumptions
assumptions
Risk free rate1 5.40% Projected Target marginal tax rate 40.0%
Estimated market equity risk premium 4.0%
Industry
Industry beta
beta analysis
analysis
Net Total Cost of Cost of
Comparable Projected debt/mkt. debt/mkt. Unlevered levered unlevered
company levered beta3 cap equity Tax rate beta4 equity equity
Company A 1.06 17.2% 22.5% 0.40 0.93 9.6% 9.1%
Company B 0.90 18.0 22.2 0.40 0.79 9.0 8.6
Company C 0.90 40.3 78.4 0.40 0.61 9.0 7.8
Company D 0.89 8.6 10.1 0.40 0.84 9.0 8.8
Average 0.94 21.0% 33.3% 0.40 0.79 9.1% 8.6%
AN AL Y SI S
Target
Target WACC
WACC calculation
calculation
Spread to Levered beta
Optimal 10-yr Pre-tax long assuming Cost of Target
debt/market treasuries Country risk term cost of unlevered levered nominal
F L OW
capitalization Optimal debt/equity (bp) premium debt beta of 0.79 equity WACC
30.0% 42.9% 175.0 0.00% 7.1% 1.00 9.4% 7.9%
40.0 66.7 200.0 0.00 7.4 1.11 9.8 7.7
C A S H
50.0 100.0 300.0 0.00 8.4 1.27 10.5 7.8

60.0 150.0 400.0 0.00 9.4 1.51 11.4 8.0
70.0 233.3 500.0 0.00 10.4 1.91 13.0 8.3
D I S C O UN T E D
1 Risk-free rate=yield-to-maturity of 10-year U.S. Treasury bond as of 1/1/01 (Source: Bloomberg)

2 Source: JPMorgan M&A research
3 Source: Barra predicted betas
4 Unlevered beta=Levered beta/(1 + (total debt/market value of equity)*(1-tax rate)). Assumes beta of debt equals zero
47
Overview
The appropriate cost of capital will depend on the entity Free cash
M&Aflow
Terminal value
which is being valued

WACC
Other topics
For
For illustrative
illustrative purposes
purposes
Risk Unlevered Optimal Re-levered Cost of Cost of
Company premium beta debt/equity beta equity financing WACC
SYSCO 5.0% 0.70 20% 0.80 9.0% 6.25% 8.2%
$1BN target 5.0%-6.5% 0.70 20% 0.80 9.0%10.3% 6.25%7.50% 8.3%9.3%
$500mm target 5.0%-7.0% 0.70 20% 0.80 9.0%10.6% 6.25%8.00% 8.4%9.7%
$200mm target 5.0%-7.5% 0.70 20% 0.80 9.0%11.0% 6.25%8.50% 8.4%10.1%
SYSCO
SYSCO WACC
WACC sensitivity
sensitivity $1bn target
$1bn target WACC
WACC sensitivity
sensitivity $200mm target
$200mm target WACC
WACC sensitivity
sensitivity
Debt/equity Debt/equity Debt/equity

10% 20% 30% 40% 10% 20% 30% 40% 10% 20% 30% 40%
AN AL Y SI S
0.65 7.8% 7.5% 7.3% 7.0% 0.70 9.1% 8.7% 8.4% 8.2% 0.70 9.8% 9.4% 9.1% 8.9%
Levered beta
Levered beta
Levered beta
0.70 8.1% 7.7% 7.5% 7.2% 0.75 9.4% 9.0% 8.7% 8.4% 0.75 10.1% 9.8% 9.4% 9.1%
0.75 8.3% 7.9% 7.7% 7.4% 0.80 9.7% 9.3% 8.9% 8.7% 0.80 10.5% 10.1% 9.7% 9.4%
0.80 8.5% 8.2% 7.8% 7.6% 0.85 10.0% 9.6% 9.2% 8.9% 0.85 10.8% 10.4% 10.0% 9.7%
F L OW
0.85 8.8% 8.4% 8.0% 7.8% 0.90 10.3% 9.8% 9.4% 9.1% 0.90 11.2% 10.7% 10.3% 10.0%
C A S H
D I S C O UN T E D
Note: Assumes 35% marginal tax rate

1 Assuming an equity risk premium of 6.5%
2 Assuming an equity risk premium of 7.5%
48
Overview
Free cash
M&Aflow
Terminal value
DCF in-class exercise

WACC
Other topics
The Forecasted EBITDA and FCF for the next three years (2005, 2006, 2007) are
EBITDA (US $mm): 450, 500, 550
FCF (US $mm): 250, 261, 277
Other assumptions:
Perpetuity growth rate of 3.0%
Terminal exit multiple of 7.5x
Unlevered beta of 0.80
Risk free rate= 4.6%
Market risk premium= 6%
Cost of debt: 6.2%
AN AL Y SI S
Marginal tax rate: 35%

Market value of equity=US $4,541mm
Net debt= US $2,524mm
F L OW
C A S H
D I S C O UN T E D
49
Overview
Free cash
M&Aflow
Terminal value
DCF in-class exercise (contd)

WACC
Other topics
Calculate
The cost of equity
WACC
PV of FCF
NPV of company Perpetual growth method
PV of Exit multiple method
What if we use end period discounting in:
Perpetual growth method
Exit multiple method
What is the valuation if we need to value the company as on March 31, 2005?
Use Exit/Perpetual growth methods using mid year conventions
AN AL Y SI S
Use Exit/Perpetual growth methods using end year conventions

F L OW
C A S H
D I S C O UN T E D
50
Overview
Free cash
M&Aflow
Terminal value
Most common errors in calculating WACC

WACC
Other topics
Cost of equity
Equity risk premium based on very long time frame (post 1926: Ibbotson data)
Substitute hurdle rate (goal) for cost of capital
Use of historical (or predicted) betas that are clearly wrong
Investment specific risk not fully incorporated (e.g., country risk premiums)
Incorrect releveraging of the cost of equity
Cost of equity based on book returns, not market expectations

AN AL Y SI S
Target capital structure

The actual, not target, capital structure is used
F L OW
WACC calculated based on book weights

C A S H
D I S C O UN T E D
51
Overview
Free cash
M&Aflow
Terminal value
Valuing synergies
WACC
Other topics
When two businesses are combined, the term synergies refers to the changes in
their aggregate operating and/or financial results attributable to their being
operated as a combined enterprise. Synergies can take many forms
Revenue enhancements
Cost savings
Raw material discounts/purchasing power
Sales and marketing overlap, Corporate overhead reductions
Distribution cost reductions, Facilities consolidation
Tax savings
Merger related expenses (restructuring, additional CAPEX, integration expenses)
The value of achievable synergies is often a key element in whether to proceed with
AN AL Y SI S
a proposed transaction
Calculate synergies for both the acquiring company and the target
Remember incremental cash flow
F L OW
Synergies are generally valued by toggling pre-tax changes to various financial

statement line items into a DCF model of the combined enterprise and simply
C A S H
measuring the incremental impact

D I S C O UN T E D
52
Overview
Free cash
M&Aflow
Terminal value
Valuing synergies
WACC
Other topics
Sources of synergy projections

Management
Research
Estimates from comparable transaction (% of sales, increase in EBITDA
margin etc.)
DCF with synergies

Valued separately from standalone DCF
Run sensitivity on synergy valuations
Other considerations
Timeline for achieving synergies
AN AL Y SI S
Run as sensitivity various cases of realization e.g., 25%, 50%, 75%, 100% realization
Tax impact
Costs incurred to achieve synergies
F L OW
C A S H
D I S C O UN T E D
53
Overview
Sensitivity analysis is vital when presenting the results of Free cash

M&Aflow
Terminal value
DCF analysis
WACC
Other topics
Recall that DCF valuation is highly sensitive to projections and assumptions
So-called sensitivity tables chart the output based on ranges of input variables
It is common to use a 3x3 table (i.e., showing three different values for each of
two input variables) to enable the reader to triangulate to the appropriate
inferences
Since DCF results are by their nature approximate, depicting sensitivity tables
enables users of DCF output to assess the degree of fuzziness in the results
As shown in our previous examples, DCF analyses using exit multiples and perpetuity
growth rates generally show sensitivities for the method used to calculate terminal
value and a range of discount rates
AN AL Y SI S
Sensitivities can be shown for any variable in the model (including financial
projections)
Judge which sensitivities would be useful to decision makers
F L OW
C A S H
D I S C O UN T E D
54
Overview
Companies with multiple businesses are often valued on a Free cash

M&Aflow
Terminal value
sum-of-the-parts basis
WACC
Other topics
This approach is sometimes referred-to as a break-up valuation

Particularly common when the company is believed to be undervalued by
the public
Better accounts for discrepancies in market conditions facing the businesses
The methodology requires estimating financial results for each business (EBIT,
EBITDA and/or net income), which can then be used with appropriate
multiples or growth rates in order to arrive at a firm value for each part
before the results are summed
Completing a sum-of-the-parts valuation can be more challenging than a

straightforward (single-business/consolidated) DCF analysis
AN AL Y SI S
Typically less detailed financial data is publicly-available for segments

Often assumptions must be made about how to allocate expenses,
especially those that are clearly shared across businesses (like corporate-
level SG&A)
F L OW
Need to consider different characteristics of each business segment

(discount rate, terminal value assumptions, etc.)
C A S H
D I S C O UN T E D
55
Agenda
Page
Introduction 1

AN ALY SI S
M E R G E R
AN D
DC F
M&A:
56
Introduction to relative valuation
Relative valuation is utilized to illustrate how the value of one company compares to
another company
Typically, relative valuation analysis is utilized in the context of stock-for-stock

exchanges to determine the appropriate exchange ratio offered to shareholders in a
transaction
The exchange ratio reflects the number of acquiror shares offered for each target
share
So if you are a target shareholder and you are offered an exchange ratio of
0.500x, you are being offer 1/2 of an acquiror share for each share of the target
you own
Several relative valuation approaches exist

Historical trading and exchange ratio analysis
Contribution analysis
AN A L Y S I S
Relative multiple and discounted cash flow analysis

Valuation of synergies
V A L U E
R E L A T I V E
57
Historical trading and exchange ratio analysis
Historical exchange ratio analysis Illustrates the relative movement in stock prices
(and implied exchange ratios, aka natural exchange ratios) looking back over a
certain timeframe
Calculated simply as the target share price on a given date divided by the acquiror
share price on the same date
Does not include any premium to the target
Provides a historical benchmark to justify the contemplated exchange ratio
Issues to consider when analyzing data include

Liquidity of shares / trading volume (small vs. large cap)
Relative market attention / analyst coverage
Multiple expansion of one of the companys peer group versus the other over the
selected time horizon
AN A L Y S I S
V A L U E
R E L A T I V E
58
Illustrative historical trading and exchange ratio analysis
Ratio at Last Last 3 Last 6 Last 12

$12.00 Current1 month1 months1 months1 months1
Acquiror shares per Target share 0.347x 0.194x 0.184x 0.203x 0.236x 0.270x
3
Implied Target share price $12.00 $6.70 $6.38 $7.02 $8.15 $9.33
$12.00 ratio as a premium 0% 79.1% 88.2% 71.0% 47.3% 28.7%
Implied Target pro forma ownership 38.7% 24.6% 23.6% 25.6% 28.9% 32.2%
Historical
Historical exchange
exchange ratio
ratio
# of acquiror shares per target share Current stock price2 Current market capitalization2
Acquiror Target Acquiror Target
0.45x $34.60 $6.70 $274.8 $89.7
0.40x
More At $12 per share = 0.347x
favorable 0.35x
to Target 0.30x
0.25x
AN A L Y S I S
0.20x
Less 0.15x Current = 0.194x
favorable
to Target 0.10x
Source: 0.05x
V A L U E
0.00x
Jun-00 Sep-00 Dec-00 Mar-01 Jun-01 Sep-01 Dec-01 Mar-02 Jun-02
R E L A T I V E
1 Represents average exchange ratio over the trailing period ended June 27, 2002
2 Closing prices as of June 27, 2002
3 Assumes acquirors current price of $34.60 per share
59
Contribution analysis
Compares the relative equity valuation of two parties to their respective

contribution to a combined companys financial performance
Typical firm value metrics would include

Revenues
EBITDA
EBIT
Unlevered free cash flow measures
Industry-specific (i.e. customers, reserves, etc.)
Typical equity value metrics would include

Net income
Levered free cash flow measures
Cautionary note: contribution analysis does not measure the growth and risk profile
AN A L Y S I S
of the two companies financial performance and differing multiples may be

justifiablie when assessing relative value
V A L U E
R E L A T I V E
60
Relative contribution analysis
$
$ millions
millions
Implied equity value Implied
Acquiror Target Total Acquiror Target exchange ratio
Market value $18,150 $7,653 $25,803 $18,150 $7,653 0.4340x
% contribution 70.3% 29.7% 70.3% 29.7%
Firm value $38,450 $19,592 $58,042 $18,150 $7,653 0.4340x
% contribution 66.2% 33.8% 70.3% 29.7%
EBITDA
2004E $5,275 $3,528 $8,803 $14,482 $11,322 0.8046x
% contribution 59.9% 40.1% 56.1% 43.9%
2005E $5,320 $3,253 $8,573 $15,716 $10,087 0.6606x
% contribution 62.1% 37.9% 60.9% 39.1%
Net income
2004E $1,790 $1,210 $3,000 $15,397 $10,406 0.6956x
% contribution 59.7% 40.3% 59.7% 40.3%
2005E $2,018 $1,380 $3,398 $15,326 $10,477 0.7036x
AN A L Y S I S
% contribution 59.4% 40.6% 59.4% 40.6%

V A L U E
1 As of 2/6/02; net debt for ACQUIROR as of 12/31/01 (per press release) and for TARGET as of 9/30/01 (per 10-Q); pro forma for acquisitions
2 2001A for ACQUIROR; based on company press release; other estimates based on JPMorgan Equity Research
3 Based on I/B/E/S consensus estimates; ACQUIROR 2002E EPS based on company guidance; TARGET EPS estimates based on I/B/E/S consensus estimates post 1/29/02
R E L A T I V E
61
Sample contribution analysis
Relative owner ship

Target Acquiror
Exchange r atio 0.5385x
Tar get 35.0%
Acquir or 65.0%
$25,308 $58,042 $8,803 $8,573 $3,000 $3,398
56.1% 59.7% 59.4%

60.9%
70.3% 70.3%
Offer =
35.0%
AN A L Y S I S
43.9% 40.3% 40.6%

39.1%
29.7% 29.7%
Market value Firm value 2002E EBITDA 2003E EBITDA 2002E Net Income 2003E Net Income
V A L U E
Implied
R E L A T I V E
ER .4340x .4340x .8046x .6606x .6956x .7036x
62
Calculating the implied exchange ratio
Company statistics
Company statistics Implied
Implied exchange
exchange ratio
ratio (equity
(equity value
value metrics)
metrics)
Acquiror
Current share price $34.22 % of net income contributed by acquiror 59.7%
Fully-diluted share count 531
Fully-diluted market cap 18,150 Fully-diluted acquiror shares 530
Net debt 20,300 Pro forma shares outstanding to yield 888
EBITDA 5,320 59.7% ownership
Net income 1,790 Implied shares issued to target 358
Current target shares outstanding 515
Target
Current share price $14.85 Implied exchange ratio based on net 0.6956x
income (358 / 515)
Fully-diluted share count 515
Fully-diluted market cap 7,653
Natural exchange ratio based on current 0.4340x
Net debt 11,939
share prices ($14.85 / $34.22)
EBITDA 3,253
Net income 1,210
AN A L Y S I S
V A L U E
R E L A T I V E
63
Calculating the implied exchange ratio (contd)
Company
Company statistics
statistics Implied
Implied exchange
exchange ratio
ratio (firm
(firm value
value metrics)
metrics)
Acquiror
Current share price $34.22 Combined firm value 58,042
Fully-diluted share count 531 Combined equity value 25,803
Fully-diluted market cap 18,150
Net debt 20,300 % EBITDA contributed by acquiror 62.1%
EBITDA 5,320 Firm value based on EBITDA contribution 36,044
Net income 1,790 Implied equity value 15,744
As a % of total equity value 60.9%
Target
Current share price $14.85 Fully-diluted acquiror share count 531
Fully-diluted share count 515 Pro forma shares outstanding to yield 61.0% acquiror 871
Fully-diluted market cap 7,653 ownership
Net debt 11,939 Implied shares issued to target 340
EBITDA 3,253 Fully-diluted target share count 515
Net income 1,210
Implied exchange ratio based on EBITDA (338 / 515) 0.66x
AN A L Y S I S
Natural exchange ratio based on current share prices 0.43x

($14.85 / $34.22)
V A L U E
R E L A T I V E
64
Class exercise
Company
Company statistics
statistics Calculate the % contribution based on
Acquiror
the EBITDA and the Net income
Current share price $12.1
Fully-diluted share count (mm) 110.3 What is the implied exchange ratio?
Net debt 450
EBITDA 172
Net income 65
Target
Fully-diluted share count 30.4
Net debt 295
EBITDA 81
Net income 25
AN A L Y S I S
V A L U E
R E L A T I V E
65
Relative multiple and discounted cash flow valuation
Compares the ranges suggested by stand-alone valuations of two companies on a

multiples or discounted cash flow basis
Step 1: Valuation the acquiror and the target separately
Step 2: Create a relative value summary
Need to consider which ends of the range it is appropriate to compare when

determining an appropriate exchange ratio / ownership percentage
High/Low and Low/High
High/High and Low/Low
AN A L Y S I S
V A L U E
R E L A T I V E
66
Sample relative value football field: Target valuation
Price
Price per
per share
share
$26.75
$20.00
$15.00
$15.00 Street case DCF
$9.75
$10.00 $10.25
Implied offer1 = $8.46
$5.50
$5.00
$5.00 $6.00
$5.00 $4.00
$4.94
Highest public $4.00 $3.75 $3.50
comp price $3.00
Lowest public
AN A L Y S I S
comp price
$0.00
15.0x to 19.0x 19.0x to 25.0x 15.0x to 20.0x 2.5x to 4.0x Mgmt. Case Street Case3
52-week
high/low 2001E EBIT 2001E cash 2002E cash LTM revenue 12% to 15% 12% to 15%
of $20.6 EPS of $0.16 EPS of $0.25 of $185.7 Discount Rate Discount Rate
EBIT exit mult. EBIT exit mult.
of 15.0x to 20.0x of 15.0x to 20.0x
V A L U E
Transaction
Public trading comparables comparables2
DCF analysis
1 Based on the offer exchange ratio of 0.311x and Pedros closing price $27.19 as of 7/12/01
2 Certain of the multiples implied by precedent transactions have been adjusted by indexing them to the movement in an index of stock prices of companies comparable to
R E L A T I V E
Pablo
3 Based on IBES EPS growth estimate and average margin estimates of brokerage reports
67
Sample relative value football field: Acquiror valuation
Price
Price per
per share
share
$50.00
DCF $43.25
$40.00 Highest public

comp price
$33.00
$29.25 $29.50
$30.00 $28.00
$30.75
$26.50
$20.00 $21.28 $22.50

Lowest public $21.00 $20.50
comp price
Current = $27.19
$10.00
AN A L Y S I S
$0.00
52-week 10.0x to 12.0x 12.0x to 15.0x 19.0x to 25.0x Sum-of-the-parts Discount rate 9% to 13%
high/low 2001E EBITDA 2001E EBIT 2001E EPS EBITDA with exit multiple
V A L U E
of $346 of $239 of $1.18 of 11.0x to 13.0x
Comparable diversified company analysis Public company analysis DCF analysis2

R E L A T I V E
1 Comparable diversified company analysis and public company analysis are based on brokerage report estimates
2 Based on management projections
68
Relative valuation summary
Less
favorable to
Acquiror
Exchange ratio1
1.000x
High/Low Low/High
$5.00/$20.50 $3.00/$33.00
0.750x
High/Low Low/High
$5.50/$30.75 $3.50/$43.25
0.488x
0.500x 0.476x 0.441x Offer: 0.311x
0.313x 0.311x
0.244x
0.250x
0.179x 0.162x 0.237x
0.219x 0.217x
0.182x
0.091x 0.081x
AN A L Y S I S
0.074x 0.073x
0.000x
Natural exchange Public Transaction Street case/Mgmt. Street case/Mgmt. Mgmt. case/Mgmt. Mgmt. case/Mgmt. Contribution
More ratio comparables to comparables to case case w ith $40 mm case case w ith $40 mm analysis
favorable to Public Public of synergies of synergies
Acquiror
comparables comparables
(Sum of Parts & (Sum of Parts &
V A L U E
Diversified) Diversified)
Discounted Cash Flow Analysis
1 Exchange ratio ranges computed by taking the high/low equity value per share of Target using various valuation methodologies over the low/high valuation of
the acquiror using various valuation methodologies
R E L A T I V E
69
Merger of Equals transactionsexample
$
$ in
in millions
millions
Acquiror Acquiror/
Ann. Transaction NewCo pro forma target Accounting
date Target Acquiror value Premium1 Chairman CEO ownership Board Split regime
3/19/01 Billiton PLC BHP Ltd $11,511 20.9% Acquiror Acquiror 58.0% 9/9 United Kingdom
6/20/00 Seagram Vivendi 40,428 22.8% Acquiror Acquiror 59.0% 14/6 France
5/17/00 Compass Group PLC Granada group PLC 8,089 3.4% Acquiror Joint 66.3% 8/8 United Kingdom
5/16/00 Lycos Inc. Terra Networks (Telefonica SA) 6,188 58.3% Acquiror Target 63.0% 11/3 Spain
2/21/00 Norwich Union PLC CGU PLC 11,858 (12.2%) Acquiror Target 58.5% 9/8 United Kingdom
1/17/00 SmithKline Beecham Glaxo Wellcome 75,961 (2.3%) Acquiror Target 58.8% 8/8 United Kingdom
12/21/99 Pharmacia & Upjohn Monsanto 26,486 (7.1%) Acquiror Target 51.0% 9/9 United States
9/27/99 VIAG AG VEBA AG 13,153 6.8% Acquiror Joint 67.0% 7/3 United States
6/30/99 Banca Commerciale Italiana SpA Banca Intesa Spa 15,940 8.5% Acquiror Joint 57.0% NA Italy
5/17/99 Hoechst Rhone Poulenc 21,918 (9.9%) Target Target 47.0% 5/5 France
1/5/99 AirTouch Communications Vodafone group PLC 60,287 40.6% Target Acquiror 50.0% 7/7 United Kingdom
1/15/99 Banco Central Hispanoamericano Banco de Santander SA 11,320 (3.6%) Joint Target 63.8% 13/12/2 Spain
12/9/98 Astra AB Zeneca Group plc 32,199 9.8% Target Acquiror 53.5% 7/7 United Kingdom
12/2/98 Synthelabo SA Sanofi SA 11,234 5.7% Acquiror Joint 64.1% 4/3/5 France
8/11/98 Amoco British Petroleum 55,040 22.7% Joint Acquiror 60.0% 13/9 United Kingdom
5/7/98 Chrysler Corp Daimler-Benz AG 40,467 38.0% Joint Joint 58.0% 6/6 United States
2/25/98 General Accident Commercial Union 11,152 (4.2%) Acquiror Target 53.6% 7/7 United Kingdom
12/8/97 Swiss Bank Union Bank of Switzerland 22,765 0.3% Acquiror Target 60.0% 4/4/1 IAS
5/12/97 Guinness PLC Grand Metropolitan 15,970 1.3% Joint Acquiror 52.8% 5/5 United Kingdom
3/7/96 Ciba-Geigy AG Sandoz AG 29,000 9.5% Target Acquiror 55.0% 8/8 IAS
AN A L Y S I S
1Premium to target share price one day prior to announcement

Source: Press releases, SEC filings, SDC
V A L U E
R E L A T I V E
70
Agenda
Page
Introduction 1

AN ALY SI S
Accretion/(dilution) review
Pro forma balance sheet analysis review
M E R G E R
AN D
DC F
M&A:
71
Introduction
Pro forma analysis provides both acquirers and targets insight into the
income statement and balance sheet impact of a transaction
Revenue, EBITDA or earnings impact
Capitalization, leverage and credit capacity impact
Valuable tool for both acquirer and target

Indicates buyers ability to pay
Suggests most appropriate form of consideration to offer
Allows buyer to predict or manage market reaction to announcement
Demonstrates landscape of competing buyers
Balance sheet and income statement impact go hand-in-hand

Both driven by form and amount of consideration
C O N S E Q U EN C E S
M E R G E R
72
Agenda
Page
Introduction 1

AN ALY SI S
M E R G E R
AN D
DC F
M&A:
73
Overview of accretion/(dilution) analysis
Accretion/(dilution) primarily measures the impact of a merger or acquisition on the

income statement of a potential buyer
Accretion/(dilution) analysis can be based on revenue, EBITDA, earnings, after-tax

cash flow, and dividends per share
EPS is most commonly used form of accretion/(dilution) analysis
Industry will typically dictate which are the most relevant metrics (e.g. wireless
telecom companies may prefer to show EBITDA)
Two methods exist for calculating accretion/(dilution)

Top down: integrated merger model
Bottom up: transaction-adjusted, estimate-based model
Key measures for accretion/(dilution)

Dollar and percent change of acquirer earnings per share
Pre-tax synergies required for break-even impact to EPS
Pro forma ownership when stock is used as an acquisition currency

Pro forma leverage/capitalization
M E R G E R
1 Note that capitalization will change when stock is used and net debt leverage levels will change when cash is used
74
Purpose of accretion/(dilution) analysis
Accretion/(dilution) analysis can be used to determine

The capacity of the acquirer (or potential acquirers) to pay a premium for a
target
Optimal form of consideration (cash, stock, other securities, combination)
Used by both buyers and sellers

Buyers identify highest price they can afford to pay and what currency to offer
Buyers evaluate how much competing bidders can afford to pay
Sellers evaluate what price potential buyers can afford to pay and in what
currency
In the context of a divestiture, sellers also evaluate their break-even sale price
and required currency
Typically, JPMorgan performs sensitivity analyses to find break-even points where

the offer price for a target results in no incremental earnings or losses to acquirers
earnings per share
M E R G E R
75
Two primary methods exist to compute M&A - DCF and M&A analysis
accretion/(dilution)
Top down Bottom up
Integrated merger model with projected balance EPS estimate-based analysis that combines acquirer
sheet and cash flow statement for target, acquirer and target projections, adjusting for impact of
Description
Description and the combined company incremental transaction-related expenses and
income
Provides most accurate picture of combined Quick and intuitive demonstration of accretive or
companies dilutive impact
Benefits
Benefits Reflects impact of debt pay-down and other Flexible analysis that can incorporate multiple
cash flow implications to net interest expense buyers or targets
and net income
Clearly and accurately shows balance sheet
impact in pro forma statistics
Difficult to efficiently incorporate multiple Risks over-simplifying pro forma analysis and over-
acquirers and targets for competitive analysis or under-stating impact to acquirer
Considerations
Considerations Relies on estimates which, although more May be inappropriate for a deal where the
robust, are also subject to uncertainty or acquirers credit rating is impacted by the
questionable assumptions transaction
Must be customized for asset deals, joint ventures

and other transactions
M E R G E R
76
Sample transaction assumptions
Transaction
Transaction description
description Target
Target
Acquirer buying target with the following

transaction assumptions: Shares outstanding 41.500
Transaction closes 12/31/04 Market capitalization $508.4
Net debt (6/30/04) 500.0

Advisory fees of 0.25% of transaction value
Firm value $1,008.4
Financing fees of 1.0% on debt issued (amortized Earnings per share:
2004E $1.20
as deferred financing fees over 7 years)
2005E 0.95
Interest rates assumptions 2006E 1.45
Tranche I ($300mm maximum senior debt): Dividend per share (annual): $0.48
Implied gross dividends paid (annual, $mm): $19.2
7.0%
Tranche II (subordinated debt): 12.5%
Interest rate earned on existing cash: 3.0%
Tax rate on incremental earnings and expenses Acquirer
Acquirer
(including net interest expense): 35%
Dividend policy of acquirer remains unchanged Shares outstanding 58.669
50% of excess purchase price allocated to Market capitalization $1,175.1
goodwill (approximately $70 million) Net debt (6/30/04) 750.0

Remaining 50% of excess purchase price Firm value $1,925.1

Earnings per share:
allocated to asset write-up and depreciated 2004E $1.56
2005E 1.68
over 20 years 2006E 1.80
Dividend per share (annual): $0.85
Target's existing debt not refinanced Implied gross dividends paid (annual, $mm): $44.6
M E R G E R
77
Key adjustments to pro forma income statement
The
The applicability
applicability of
of most
most income
income statement
statement adjustments
adjustments depends
depends on
on the
the consideration
consideration issued
issued to
to the
the seller
seller and
and the
the way
way the
the
acquiror funds an acquisition
acquiror funds an acquisition
Consideration
Adjustment Stock Cash Mix
After-tax financing fee amortization X X
Non-deductible advisory fee amortization
After-tax incremental DD&A from asset write-up X X X
After-tax interest on transaction debt X X
After-tax interest deduction from cash used X X X
After-tax interest (loss) gain on dividend shortfall X X X
After-tax synergies X X X
Transaction goodwill impairment X X X

Change in pro forma fully diluted shares X X

M E R G E R
78
What is in a consensus estimate?
While
While First
First Call
Call or
or I/B/E/S
I/B/E/S estimates
estimates may
may provide
provide a
a perceived
perceived Street
Street consensus,
consensus, they
they introduce
introduce some
some degree
degree of
of uncertainty
uncertainty
First Call and I/B/E/S consensus estimates are based on an aggregation of research analysts
estimates, with little discretion applied to mean and median calculations
Quality of estimates and analysts varies dramatically across consensus samples
Modeling conventions are often not explained or apparent
Analysts may be assuming different projected share counts, rather than net income
Some estimates included in consensus numbers are out-dated

May not reflect updated company guidance or recent financial results
May not reflect abrupt changes to underlying industry economics
May not reflect recent M&A transactions or securities offerings
Items embedded in consensus estimates are not always clearly explained or uniform
across samples
Fully diluted share assumptions and treatment of options and convertibles may vary
Interest expense
Tax rates
Accounting policies
Stock-based compensation and amortization of intangibles other than goodwill
M E R G E R
79
Transaction assumptions are the foundation of all M&A - DCF and M&A analysis
sound analysis
Always
Always clearly
clearly describe
describe transaction
transaction assumptions
assumptions
Choose an appropriate closing date reflecting available information and transaction structure
Timing of process requirements for closing (share registration, shareholder votes, etc.)
Timing of regulatory requirements for closing (HSR review, etc.)
Seasonality of industry economics and impact on estimates or calendarization
Capital structures should best reflect current circumstances

Equity currency should be reviewed in context of recent share price and larger equity market
performance
Cash deals should reflect reasonable interest rates and lending market capacity
Pro forma leverage and interest coverage levels should be consistent with acquirers desired credit
rating
Both advisory and financing fees have a meaningful impact on pro forma financials
Although equity analysts tend to look through some extraordinary charges, advisory and other one-
time fees will impact the cash balance used in the transaction and subsequent annual interest
expense
Amortization of financing fees will impact EPS over the immediate future of the combined entity
Tax rate on incremental earnings and expenses should reflect acquirors and targets combined tax
efficiencies and adjustments should be made to post-transaction tax expenses for potential NOLs
assumed by an acquirer
M E R G E R
80
Sample transaction100% stock consideration
Assumptions
Assumptions Earnings
Earnings impact
impact ($
($ millions,
millions, except
except per
per share
share data)
data)
2003 2004
Acquirer share price: $20.03 Acquirer EPS $1.68 $1.80
2003 P/E 12.0x Acquirer net income 98.3 105.7
2004 P/E 11.1
Target EPS $0.95 $1.45
Target net income 39.4 60.2
Acquirer shares outstanding 58.669
Adjustments
Target share price: $12.25
2003 P/E 12.9x After-tax financing fee amortization ($0.0) ($0.0)
Non-deductible advisory fee amortization 0.0 0.0
2004 P/E 8.4
After-tax DD&A from asset write-up (2.3) (2.3)
After-tax interest on transaction debt (0.0) (0.0)
Transaction assuming 25% premium After-tax interest deduction from cash used (0.1) (0.1)
Offer price (assuming 25% premium) $15.31 After-tax interest (loss) gain on dividend shortfall (0.2) (0.3)
Shares acquired 42.468 After-tax synergies 0.0 0.0
Transaction goodwill amortization (or impairment) 0.0 0.0
Implied exchange ratio (T/A) 0.764x Other reductions 0.0 0.0
Shares issued 32.466 Total adjustments to net income (2.5) (2.7)
Tax rate on incremental expenses: 35.0% Pro forma net income $135.2 $163.2
Pro forma shares outstanding 91.135 91.135
Pro forma EPS $1.48 $1.79

Accretion/(dilution) ($) ($0.19) ($0.01)

Accretion/(dilution) (%) (11.5%) (0.6%)
Pre-tax synergies to break-even $26.9 $1.5
1 Should be calculated using the offer price not current target price
M E R G E R
Used to fund transaction expenses and advisory fees of $2.9 million
81
Considerations for a stock transaction
P/Es and relative valuations play a meaningful role in accretion/(dilution) analysis

High P/E of an acquirer may imply stock may be cheap acquisition currency,
relative to lower P/E stock or the implied debt P/E
A number of issues will play an important role in the optics, attitudes and receptivity
of principals and investors in a transaction
Exchange ratios should not be grossly inconsistent with historical relative trading
performance of acquirer and target
Purchase price and pro forma ownership should take into account contribution
analysis
Flow back and sell-off of acquirer stock could meaningfully affect acquirers share
prices on announcement/closing
Cross-shareholder analysis
Whether acquirer and target are included in the same indexes, if any
Fund limitations on owning international stocks and/or stocks not listed on local
exchanges
Dividend policy implications of receiving acquirer stock
M E R G E R
82
Sample transaction100% cash consideration
Earnings
Earnings impact
impact
Assumptions
Assumptions Earnings
Earnings impact
impact
Figures in millions, except per share data 2003 2004
Target share price: $12.25 Acquirer EPS $1.68 $1.80
Offer price (assuming 25% premium) 15.31 Acquirer net income 98.3 105.7
Shares acquired 42.468 Target EPS $0.95 $1.45

Debt issued to fund acquisition:
Equity purchased with cash $650.3 Adjustments
Transaction fees 2.9 After-tax financing fee amortization ($0.6) ($0.6)
Financing fees 6.6 Non-deductible advisory fee amortization 0.0 0.0
Cash balance used in transaction (0.0) After-tax DD&A from asset write-up (2.3) (2.3)
Total debt raised $659.8 After-tax interest on transaction debt (42.9) (44.8)
After-tax interest deduction from cash used 0.0 0.0
Debt allocation: After-tax interest (loss) gain on dividend shortfall 0.4 0.8
Tranche I $300.0 After-tax synergies 0.0 0.0
Tranche II 359.8 Transaction goodwill amortization (or impairment) 0.0 0.0
Other reductions 0.0 0.0
Interest Rates: Total adjustments to net income (45.4) (47.0)
Tranche I 7.0%
Tranche II 12.5% Pro forma net income $92.4 $118.9
Pro forma shares outstanding 58.669 58.669
Interest rate on foregone cash balance 3.0%
Tax rate on incremental earnings 35.0% Accretion/(dilution) ($) ($0.10) $0.23
Accretion/(dilution) (%) (6.1%) 12.5%
M E R G E R
Pre-tax synergies to break-even $9.1 NM

1 Should be calculated using the offer price not current target price
83
Considerations for a cash transaction
Use multiple tranches of debt where appropriate

Reflects capital structure and market capacity limitations for larger deals
Varying interest rate on debt tranches will impact interest expense on offer price increases or
decreases
Note that depending on debt mix, stock may be more or less appropriate as an acquisition
currency
Financing assumptions should reflect both acquirers stand-alone and combined debt capacity and
ratings circumstances
Debt coverage and capitalization statistics should be included to highlight potential ratings issues
and support interest rate assumptions
Current and recent ratings history of acquirer should be reviewed to confirm ability to issue debt
securities
Covenants of existing acquirer debt should be considered
Review transaction and pro forma financials with ratings advisory and DCM teams to determine
appropriate rates
Use existing acquirer cash sparingly, if at all

Existing cash is likely used to meet working capital funding requirements

Minimum cash balance may be required for debt covenants
Opportunity cost of using cash on hand should always be contemplated and reflected in interest
expense
Restricted cash considerations
M E R G E R
84
Sample transaction50% cash/50% stock consideration
Earnings
Earnings impact
impact
Mixed
Mixed consideration
consideration assumptions
assumptions Earnings impact
Earnings impact
Figures in millions, except per share data 2003 2004

Target share price: $12.25 Acquirer EPS $1.68 $1.80
Offer price (assuming 25% premium) 15.31 Acquirer net income 98.3 105.7
Shares acquired 42.468 Target EPS $0.95 $1.45

Shares issued 16.233
Adjustments
Debt issued to fund acquisition: After-tax financing fee amortization ($0.3) ($0.3)
Equity purchased with cash $325.1 Non-deductible advisory/ other fee 0.0 0.0
Transaction fees 2.9 After-tax DD&A from asset write-up (2.3) (2.3)
Financing fees 3.3 After-tax interest on transaction debt (16.2) (16.9)
Cash balance used in transaction (0.0) After-tax interest deduction from cash used 0.0 0.0
Total debt raised $331.3 After-tax interest (loss) gain on dividend shortfall 0.1 0.2
After-tax synergies 0.0 0.0
Debt allocation: Transaction goodwill amortization (or impairment) 0.0 0.0
Tranche I $300.0 Other reductions 0.0 0.0
Tranche II 31.3 Total adjustments to net income (18.7) (19.3)
Interest Rates: Pro forma net income $119.1 $146.6

Tranche I 7.0% Pro forma shares outstanding 74.902 74.902
Tranche II 12.5%
Interest rate foregone on cash balance 3.0% Accretion/(dilution) ($) ($0.09) $0.16
Accretion/(dilution) (%) (5.1%) 8.6%
Tax rate on incremental earnings 35.0%
M E R G E R
Pre-tax synergies to break-even $9.9 NM
85
The role of P/E valuations in accretion/(dilution)
For stock-for-stock deals, accretion or dilution potential will usually be evident by simply
comparing the P/E multiples of the acquirer and the target
If the acquirer has a higher P/E than the target, the deal will be accretive because the acquirer
is buying more EPS than the target shareholders are accepting as consideration
If the acquirer has a lower P/E than the target, the deal will be dilutive because the acquirer is
buying less EPS than the target shareholders are accepting as consideration
Remember to take the premium into account when calculating the targets P/E
Utility of comparison will also depend on transaction assumptions regarding goodwill impairment
or other asset amortization
For 100% cash transactions, the cost of debt (interest payments) and cost of acquiring the targets
earnings will determine the accretive or dilutive impact of a transaction
Where the inverse cost of debt (1/(after-tax cost of debt)) is greater than the P/E of the target,
the deal will be accretive
Where the inverse cost of debt is lower than the P/E of the target, the deal will be dilutive
M E R G E R
86
Presenting accretion/(dilution) with sensitivities
Sensitivities provide the total picture of a transactions potential impact; relevant

sensitivities to demonstrate may include
Premium (discount)
Consideration offered (% of stock/% of cash)
y Acquirers stock price
y Earnings per share
y Synergies
Interest rate(s) on debt issued
Sensitivities should reflect consideration specifics

Purchase price and ownership (stock)
2003
2003 accretion/(dilution)(%
accretion/(dilution)(% per
per share)
share) 2003
2003 synergies
synergies to
to break-even($mm)
break-even($mm)
Stock consideration Stock consideration
50.0% 62.5% 75.0% 87.5% 100.0% 50.0% 62.5% 75.0% 87.5% 100.0%
10.0% 1.0% (1.1%) (3.0%) (4.8%) (6.4%) 10.0% NM $2.2 $6.3 $10.4 $14.4
20.0% (3.0%) (4.6%) (6.5%) (8.3%) (9.8%) Premium 20.0% 5.8 9.3 13.8 18.3 22.8
Premium
30.0% (7.7%) (8.4%) (10.2%) (11.9%) (13.4%) 30.0% 15.0 17.3 22.3 27.2 32.1
40.0% (14.1%) (13.5%) (15.2%) (16.8%) (18.1%) 40.0% 28.2 28.8 34.3 39.9 45.3
50.0% (20.2%) (19.0%) (19.9%) (21.3%) (22.5%) 50.0% 41.7 41.9 46.6 52.8 58.9
M E R G E R
87
Relevant sample transaction sensitivities
Stock
Stock deals
deals
2003
per share)
share) 2003
per share)
share)
Acquirer stock price Pre-tax synergies realized 2003
$19.00 $20.03 $21.00 $22.00 $23.00 $5.0 $10.0 $15.0 $20.0 $25.0
10.0% (8.1%) (6.4%) (5.0%) (3.5%) (2.2%) 10.0% (4.2%) (2.0%) 0.2% 2.5% 4.7%
20.0% (11.6%) (9.8%) (8.3%) (6.8%) (5.5%) 20.0% (7.7%) (5.5%) (3.3%) (1.2%) 1.0%
Premium
Premium
30.0% (15.2%) (13.4%) (11.8%) (10.3%) (8.9%) 30.0% (11.3%) (9.2%) (7.1%) (5.0%) (2.9%)
40.0% (20.0%) (18.1%) (16.5%) (15.0%) (13.5%) 40.0% (16.1%) (14.1%) (12.1%) (10.1%) (8.1%)
50.0% (24.4%) (22.5%) (20.9%) (19.3%) (17.8%) 50.0% (20.6%) (18.7%) (16.8%) (14.9%) (13.0%)
Cash
Cash deals
deals
2003
per share)
share) 2003
per share)
share)
Interest rate on senior debt (Tranche 1) Blended interest rate (%)
6.5% 7.0% 7.5% 8.0% 8.5% 11.0% 10.5% 10.0% 9.5% 9.0%
10.0% 3.1% 2.1% 1.1% 0.1% (0.9%) 10.0% (2.3%) (0.1%) 2.1% 4.2% 6.4%
20.0% (2.4%) (3.4%) (4.3%) (5.3%) (6.3%) 20.0% (7.7%) (5.5%) (3.4%) (1.2%) 1.0%
Premium
Premium
30.0% (8.4%) (9.4%) (10.4%) (11.4%) (12.4%) 30.0% (13.8%) (11.6%) (9.4%) (7.2%) (5.1%)
40.0% (17.1%) (18.1%) (19.1%) (20.1%) (21.1%) 40.0% (22.5%) (20.3%) (18.1%) (15.9%) (13.7%)
50.0% (25.9%) (26.9%) (27.9%) (28.9%) (29.9%) 50.0% (31.3%) (29.1%) (26.9%) (24.7%) (22.6%)
M E R G E R
88
Synergies and transaction related costs
Synergies
For top-down modeling simplicity, assume synergies come from cost-savings unless told
otherwise
Revenue synergies
Incremental revenues may have costs associated with them that need to be reflected
in any synergy calculations (e.g variable margins on incremental revenues)
Equity markets heavily discount or, in many cases, disregard revenue synergies, as
they are typically difficult to quantify and accurately project
Synergies are typically realized gradually over time and should be phased in accordingly
It may be prudent to risk-adjust any expected synergies to account for ability to
realize them and/or for negative synergies (i.e., integration costs)
Consider the cash flow impact of synergies
One-time charges and expenses

Acquiring companies will incur one-time merger-related costs due to reorganization,
severance packages
One-time charges are disclosed in SEC filings
From a valuation perspective, the Street looks through one-time charges

Include the net interest impact of cash changes
M E R G E R
89
Additional items to consider
Tax benefits
In assuming additional options are exercised under premium scenarios a tax shield will be generated
based on the implied deductible compensation expense generated from the vesting / exercise of
options at a discount to the acquisition price
Asset write-ups have tax implications1
Acquirers may be forced to pay interest on interest

In using cash and thereby raising debt, an acquirer will incur future interest and amortization
payments that may require additional borrowing
AccretionOne calculation method
Asset write-ups and additional depreciation expenses

While asset write-ups will reduce goodwill generated in a transaction, they will increase annual
depreciation expenses based on the incremental increase in depreciable assets
Limiting asset write-ups will reduce negative impact of increased depreciation expenses
In some cases, asset write-downs may impact EPS accretion / dilution
Impact of dividends paid by acquirer

Additional cash will be necessary to fund new dividends paid and should be reflected in incremental
expenses
Dividend accretion/(dilution) analysis may be relevant to determine appropriate premium
M E R G E R
1 Write-ups create a deferred tax liability (equal to the write-up multiplied by the tax rate)
90
Summary considerations for EPS accretion/(dilution) M&A - DCF and M&A analysis
analysis
EPS-based accretion/(dilution) is only a back-of-the-envelope exercise and is not a

substitute for an integrated merger model
Does not necessarily reflect cash flow implications and debt pay-down capabilities of
combined company
EPS estimates should be used with caution

First Call and I/B/E/S estimates are consensus numbers that do not always reflect
consistent underlying assumptions
Small differences in EPS figures can have dramatic impact on net income ($0.05 per
share on 200 million shares reflects a $10 million variance in net income)
Share count of target must be a dynamic number

Share count should increase (decrease) with offer price to reflect additional (reduced)
shares underlying in-the-money options
Negative net income targets CANNOT create meaningful accretion
Accretion/(dilution) should always be sanity-checked

Relative P/Es
Acquirers cost of debt vs. cost of targets earnings
Accretion/(dilution) should always be checked with your calculator

M E R G E R
91
Agenda
Page
Introduction 1

AN ALY SI S
M E R G E R
AN D
DC F
M&A:
92
Overview of pro forma balance sheet analysis
Pro forma balance sheet analysis provides a means of assessing the impact of a
potential transaction on an acquirers cost of borrowing, market access, and
financial flexibility
Two methods exist for demonstrating balance sheet impact:

Top down: integrated merger model with income statement, balance sheet and
cash flow statement (preferred)
Bottom up: transaction-adjusted, LTM-based model
Pro forma balance sheet analysis relies primarily upon a comparison of an acquirers
pre- and post-acquisition credit metrics
Key credit metrics include:

Pretax interest coverage
EBITDA interest coverage
Funds from operations to interest
Funds from operations to debt

Debt to EBITDA
Debt to book capitalization
M E R G E R
93
Significance of pro forma balance sheet analysis
Pro forma balance sheet analysis is critical in determining

The debt-financed acquisition capacity of an acquirer (or competing bidders)
Required equity component of an offer to ensure a particular rating outcome
Financing implications of a particular transaction structure (cost of capital and
market access)
In a divestiture, the pro forma credit rating of the seller and the minimum level of
cash consideration needed
Used by both buyers and sellers

Buyers identify highest price they can afford to pay and how much cash can be
offered
Buyers evaluate how much other competitive bidders can afford to pay
Sellers evaluate how much potential buyers can afford to pay and how much cash
to demand
Typically, JPMorgan performs sensitivity analyses to address relevant inflection

points where the offer price for a target results in meaningful changes to a combined
capital structure
M E R G E R
94
Credit ratings as a key financing decision driver
A companys corporate credit rating determines its

Cost of borrowing
Breadth and depth of access to the capital markets
Financial flexibility (liquidity/covenant constraints)
Pro forma balance sheet analysis allows potential acquirers to assess

leverage breakpoints and their associated ratings outcomes in order to
develop a comprehensive financing plan
Significant debt-financed transactions can erode credit profile and can

lead to a ratings downgrade
The determination of potential financing structures is often bound by the

trade-offs between maximizing EPS subject to limiting ratings pressure
M E R G E R
95
Sample transaction 100% cash consideration
Acquirer Target Adjustments Pro forma

Balance sheet:
Total debt $800.0 $575.0 $659.8 $2,034.8
Shareholders equity value 950.0 525.0 (525.0) 950.0
Minority interest 0.0 0.0 0.0 0.0
Income statement:
LTM EBITDA $226.0 $119.0 $345.0
LTM EBIT 176.0 94.0 270.0
LTM interest expense 55.0 40.0 42.6 137.6
Capitalization:
Debt/equity 84.2% 109.5% 214.2%
Debt/total capitalization1 45.7% 52.3% 68.2%
Coverage ratios:
Debt/LTM EBITDA 3.5x 4.8x 5.9x
Debt/LTM EBIT 4.5 6.1 7.5

LTM EBITDA/interest 4.1 3.0 2.5
LTM EBIT/interest 3.2 2.4 2.0
Note: excludes lease-related leverage and hybrid securities

M E R G E R
1 Includes minority interest
96
Sample transaction100% stock consideration
Acquirer Target Adjustments Pro forma

Balance sheet:
Total debt $800.0 $575.0 $0.0 $1,375.0
Shareholders equity value 950.0 525.0 125.3 1,600.3
Minority interest 0.0 0.0 0.0 0.0
Income statement:
LTM EBITDA $226.0 $119.0 $345.0
LTM EBIT 176.0 94.0 270.0
LTM interest expense 55.0 40.0 0.0 95.0
Capitalization:
Debt/equity 84.2% 109.5% 85.9%
Debt/total capitalization1 45.7% 52.3% 46.2%
Coverage ratios:
Debt/LTM EBITDA 3.5x 4.8x 4.0x
Debt/LTM EBIT 4.5 6.1 5.1

LTM EBITDA/interest 4.1 3.0 3.6
LTM EBIT/interest 3.2 2.4 2.8
Note: excludes lease-related leverage and hybrid securities

M E R G E R
1 Includes minority interest
97
Pro forma balance sheet sensitivities
Debt/total
Debt/total capitalization
capitalization
Stock consideration
Similar to EPS analysis, sensitivities provide
0.0% 25.0% 50.0% 75.0% 100.0%
the whole picture
10.0% 67.3% 62.4% 57.4% 52.5% 47.5%
Sensitivities should demonstrate the impact 20.0% 67.9% 62.6% 57.3% 52.0% 46.6%
Premium
of changes to relevant metrics 30.0% 68.5% 62.8% 57.2% 51.5% 45.7%
40.0% 69.4% 63.2% 57.0% 50.7% 44.4%
Consideration (stock vs. cash)
50.0% 70.3% 63.5% 56.8% 50.0% 43.2%
Estimates (EBITDA)
Assumptions (premium, interest rates,
etc.)
Debt/EBITDA
Debt/EBITDA EBITDA/interest
EBITDA/interest
Stock consideration Stock consideration
0.0% 25.0% 50.0% 75.0% 100.0% 0.0% 25.0% 50.0% 75.0% 100.0%
10.0% 5.66x 5.24x 4.83x 4.41x 3.99x 10.0% 2.63x 2.89x 3.19x 3.39x 3.63x
20.0% 5.82 5.36 4.91 4.45 3.99 20.0% 2.54 2.81 3.13 3.37 3.63
Premium
Premium
30.0% 6.00 5.49 4.99 4.49 3.99 30.0% 2.45 2.73 3.06 3.35 3.63
40.0% 6.25 5.68 5.12 4.56 3.99 40.0% 2.34 2.62 2.97 3.32 3.63
50.0% 6.50 5.88 5.25 4.62 3.99 50.0% 2.23 2.51 2.88 3.29 3.63
M E R G E R
98

JP Morgan DCF and Merger Model PDF

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

JP Morgan DCF and Merger Model PDF

Uploaded by

Copyright:

Available Formats

S T R I C TL Y P R I V A T E AN D C O N F I D E N T I A L

Discounted cash flow analysis 6

Relative value analysis 56

Risk in cash flows EPS impact

The valuation process

(1) Discounted (2) Publicly Traded (3) Comparable (4) Leveraged

Price per share

of $20.6 EPS of $0.16 EPS of $0.25 Discount Rate Discount Rate

A primer: firm value vs. equity value

Firm value = Market value of all capital invested in a business(1)

Equity value = Market value of the shareholders equity

Assets Liabilities and Shareholders Equity

Net debt, etc.

Discounted cash flow analysis 6

Relative value analysis 56

Discounted cash flow analysis as a valuation methodology

prospective performance share price

Does not include a and capital

Overview of DCF analysis

DCF analysis is one of the most fundamental and commonly-used valuation

Comparable transaction analysis

DCF analysis may be the only valuation method utilized, particularly if no

Overview of DCF analysis

DCF analysis is a forward-looking valuation approach, based on several key

Depending on practical requirements and availability of data, DCF analysis can

There is no single correct method of performing DCF analysis, but certain

rules of thumb always apply

You must apply judgment in determining each assumption

The process of DCF analysis

Estimate the exit multiple and/or growth rate in perpetuity of the

Estimate the companys weighted-average cost of capital to

Determine a range of values for the enterprise by discounting the

DCF theory and its application

The cash-flow streams that are discounted include

the cost of equity capital (often referred to as flows to shareholders or dividend

The two basic DCF approaches must not be confused

DCF of unlevered cash flows (the focus of these materials)

DCF of levered cash flows (most common in valuation of financial institutions)

perpetuity growth rate

Hence, always present a range for the valuation!

Three key drivers

Sensitize appropriately (base projection variables, synergies, discount rates,

Think about other value enhancers and detractors

Always double-check with a calculator!

The first step in DCF analysis is projection of unlevered Free cash

free cash flows

Calculation of unlevered free cash flow begins with financial projections

Quality of DCF analysis is a function of the quality of projections

Sources of projections include

Projecting financial statements

Most important assumptions

Analyze projections for consistency

CAPEX and depreciation should converge over time

owners after taxes and reinvestment

Equals: Tax-effected EBITA

Less: Capital expenditures

Equals: Unlevered free cash flow

Example: Calculating unlevered free cash flows

Unlevered free cash flow 40.3 46.8 53.8 61.4 69.6

Valuing the incremental effects of changes in projected Free cash

In performing DCF analysis, we often need to determine the incremental impact on

These incremental effects can be valued by discounting them independently (net of

be discounted to the present