Company valuation is an art not a science - Essay Example

There are several rationales for mergers. Companies undertake M/A because of (a) synergy created by operating and financial economies, differential efficiency, or increased market power; (b) tax considerations; (c) purchase of assets below their replacement cost; and (d) diversification, not to mention possible managers’ personal incentives. For any of the four economic reasons mentioned, the M/A is successfully undertaken only if the resultant post-M/A firm attains a value greater than sum of the two separate firms (Brigham and House, 2004, p.796-798). A M/A is necessarily a sale or exchange, which means that the determination of company values is a requisite.

There are various methods of valuation that may be undertaking for the purpose of M/A. These include assessing the target or merging companies’ book value, economic value, replacement value, and break-up value. The book value is the accounting value, that is, the net amount of the company’s total assets less total liabilities; the per-share value is arrived at by dividing this net amount by the number of common shares. As conveyed by its definition, the book value of a company is a straightforward valuation method based on historical transaction costs.

The dividend-discount model, the most popular equity valuation method to determine the worth of the firm to the shareholders, is equal to the present value of all future cash dividends. This would prove useful to a company contemplating a financial merger that did not involve unifying operations. The target company is expected to conduct its business in the same way it has before the merger or acquisition, and the acquiring company expects to benefit in the nature of a majority stockholder (Helfert, 2003, pp. 390). The replacement or reproduction value is the amount that would be required to replace an existing fixed asset in kind.

Replacement value is one