Discussion Issues and Derivations

  1. Valuing Synergy
    Synergy is the increase in value that occurs when two firms, with different products, markets or functional strengths, come together. Thus, synergy can be written as follows:
    V(AB) = V(A) + V(B) + Synergy
    Synergy can come from variety of sources but it shows up in value in one of three ways:
    a. as an increase in current cash flows (resulting from economies of scale or related synergies)
    b. as an increase in growth (resulting from growth synergies)
    c. as a reduction in the cost of capital (resulting from a higher debt capacity or lower costs of debt)
  2. Valuing Control
    The value of control is really the difference in value between the firm optimally managed, and the value of the firm under the status quo. The value of control is small in well managed firms and large in poorly managed firms.
    To value control, we need to do the following:
    a. Value the firm under incumbent management, and current management policy
    b. Value the firm under optimal management
    c. Value of Control = Value of firm under optimal management - Value of firm under incumbent management