Basic, lesson 1 of 3
Standalone value from the buyer's seat
Before synergies, a buyer asks what the target is worth exactly as it is. The answer depends on the target's cash flows and the target's risk, not the buyer's.
9 min, 3 checks
1Cash flows the target produces alone
Standalone value is the present value of the free cash flow the target would generate without the deal. Corp dev builds it from the target's own plan, then adjusts the plan for what diligence finds. Synergies are kept out on purpose so the team can see how much of the price depends on them.
Value = FCF next year / (Discount rate - Long-term growth)
The shortcut for a business growing steadily forever. A full model projects five to ten years and then uses this for the rest.
Worked example
A steady target
- 1Free cash flow next year: $50m.
- 2Long-term growth: 3%.
- 3Discount rate for the target's risk: 9%.
Value is $50m / (9% - 3%) = $833m.
Check 1
A target will produce $60m of free cash flow next year, growing 2% a year. Its discount rate is 10%. What is it worth, in $m?
2Whose discount rate
A large, stable buyer often has a lower cost of capital than the target. It is tempting to discount the target at the buyer's rate, since the buyer is the one paying. That is a mistake. The risk of the cash flows belongs to the business producing them. A low-risk utility buying a risky software company does not make the software company less risky.
Check 2
Same $50m target growing 3%. The buyer discounts it at its own 7% cost of capital instead of the target's 9%. What value does it get, in $m?
Check 3
Which discount rate should a buyer use to value a target's standalone cash flows?
Terms in this lesson: Synergies.
3 checks in this lesson. Sign in to keep your progress.