Question

Trying to Add Value - Buying and Selling Divisions” Three large local companies (PepsiCo, Frontier, and General Electric) have all announced major acquisitions or divestitures in the last 10 days. For every buyer there is a seller and vice-versa, and each side of the transaction must be thinking that the transaction will create EVA (Economic Value will be Added for the Enterprise), else they wouldn’t do it. Look at these three situations. What is common and what is different for the firms making the analysis? You could wrote a dissertation here… Please comment in the narrow framework using the formula for EVA (NPV of cash flows is less than NPV of cash spent, or if selling, the NPV of cash received is more than the NPV of cash you would have received in the future).

Answer 1

EVA ( Economic Value Added) is the technique to measure that economic condition or sustainability of enterprise in current situation or projected one. It gives the whole idea about the value addition to the companies wealth and profitability by operations.

In case of acquisition, divestiture, selling, buying or acquisition of business the Economic Value Added is the major analysis tool to make such decisions

common and different aspects for the firms making the analysis in case of acquisitions or divestitures are :

Common Aspects :

• Total Revenues and its growth in future combine and standalone be calculated at actual and projected as entity acquired. It will increases overall profitability.
• In EVA the actual cash flow is considered as it is after tax before depreciation, which means it does not deducted non cash items like depreciation as there is no actual cash outflow.

Different Aspects :

• The expected return or value of shareholders wealth can be different than the investing companies expected return , which can lead the difference in valuation of the company
• In EVA the uncertainties are not measured and hence it will differ the situation in case of unexpected situations.

comment in the narrow framework using the formula for EVA (NPV of cash flows is less than NPV of cash spent, or if selling, the NPV of cash received is more than the NPV of cash you would have received in the future) :

1. EVA ( NPV of cash flows is less than NPV of cash spent ) :

• If in case of cash flow the non cash items are not added in the cash flows and considered in cash spent then it the cash flows are not correct.
• In such case it may happens that the combined cash flows are not considered or future projected cash flows are not considered then in this case the decision for not acquiring company affected as it can be profitable in future.

2. EVA ( selling ) :

• In such case the weighted average rate of return can be differ with Expected Return of shareholders and acquirers , it changes the valuation and share price.
• If EVA of acquiring and acquirer company are different then in case of which companies higher EVA will get higher weightage. It does not consider hidden aspects like Goodwill, Brand etc.

3.EVA ( NPV of cash received is more than the NPV of cash you would have received in the future ) :

• In such case the projected cash flow is lower than current will lead the adverse decision of acquiring the company. But these are projections which can be differ by any factor.
• In such case the synergy effect may be different and more optimistic than in the given case, which differs the decision of acquisition or divestiture of company.