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The total value created by the acquisition is $18.63 million. A 50% premium would give $6.25
million of this incremental value to Digerati‟s shareholders. After $3 million of acquisition costs,
$9.38 million remains for MC‟s shareholders. Thus, each share should increase by $3.13 ($9.38
million divided by the three million shares outstanding) to $33.13.
Note that the solution to Example 5 assumes the market knows about and accepts the value creation
estimates described. Investors will often discount management‟s estimates of value creation, believing
them to be overly optimistic or doubting the timetable for their realization. In practice, estimating the
synergistic cash flows and the appropriate discount rates is the analyst‟s most difficult task.
Summary: The sole motivation for initiating a merger or acquisition should be increased wealth for
the acquirer‟s shareholders. We know from the empirical evidence presented earlier in the track record
section that many transactions fail to meet this simple requirement. The main point of this section on
creating value is that value can come from only two sources—incremental future cash flows or
reduced risk. If we can estimate these parameters in the future, we can measure the acquisition‟s
synergy, or potential for value creation. For the deal to benefit the acquirer‟s shareholders,
management must do two things. The first is to make sure the premium paid is less than the potential
synergy. Many acquisitions that make strategic sense and generate positive synergies fail financially
simply because the bidder overpays for the target. The second task for the acquirer‟s management is to
implement the steps needed after the transaction is completed to realize the deal‟s potential for value
creation. This is a major challenge and is discussed further in the section on postmerger
implementation. In the next section we briefly present some of the key issues managers should
consider when initiating and structuring acquisitions.
Some Practical Considerations
In this section, we briefly discuss the following issues you may encounter in developing and executing
a successful M&A strategy:
• Identifying candidates.
• Cash versus stock deals.
• Purchase accounting.
• Tax considerations.
• Antitrust concerns.
• Cross-border deals.
This is not meant to be a comprehensive presentation of these topics. Rather, the important aspects
of each are described with the focus on how they can influence cash flows and synergy. The goal is to