Business Memo
Dear Harry,
In relation to the document forwarded by you stating the 60% acquisition premium to Framingham’s stockholders, I raise my concern for the underlying assumptions used for calculating the premium amount. I am sure that you understand the premium of 60% is high and we should aggressively check the assumptions behind those calculations. If we do not check the assumptions meticulously, we will be eventually end up transferring our wealth to the shareholders of the acquired company.
Secondly, M&A related calculations are performed using long-term growth rate for the cash flows of the target company. Here also, valuation with over-optimistic growth rate results in higher valuation for the target company as many a times we fail to perform the scenario and sensitivity analysis for the cash flow.
Last, the bias effect is the most prominent and most detrimental when it comes to valuation of the target company. At times of valuation, we tend to give higher value for something closely associated to us, and in this case, the target firm’s manage share a conflict of interest with you.
Therefore, I strongly recommend that you should reconsider the assumptions underlying your valuation and should hold a meet with the entire finance department to discuss the valuation and underlying assumptions to come up with a rational estimate for the premium to be paid to the target firm.
References
Md. Abdur Raquib, M. P. (2003). Strategic Issues Relating to Corporate Mergers and Acquisitions for Small and Medium Companies . Asia Pacific Management Review, 99-112.
