PART EIGHT Topics in Corporate Finance

1. Do not ignore market values. There is no point to and little gain from estimating the value of a publicly traded firm when that value can be directly observed. The current market value represents a consensus opinion of investors concerning the firm's value (under existing management). Use this value as a starting point. If the firm is not publicly held, then the place to start is with similar firms that are publicly held.

2. Estimate only incremental cash flows. It is important to estimate the incremental cash flows that will result from the acquisition. Only incremental cash flows from an acquisition will add value to the acquiring firm. Acquisition analysis should thus focus only on the newly created, incremental cash flows from the proposed acquisition.

3. Use the correct discount rate. The discount rate should be the required rate of return for the incremental cash flows associated with the acquisition. It should reflect the risk associated with the use of funds, not the source. In particular, if Firm A is acquiring Firm B, then Firm A's cost of capital is not particularly relevant. Firm B's cost of capital is a much more appropriate discount rate because it reflects the risk of Firm B's cash flows.

4. Be aware of transactions costs. An acquisition may involve substantial (and sometimes astounding) transactions costs. These will include fees to investment bankers, legal fees, and disclosure requirements.

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