Net present Value, Mergers and acquisitions
PART I
- Net present value (NPV) is a sophisticated capital budgeting technique; found by subtracting a project’s initial investment from the total present value of its future cash inflows discounted at a rate equal to the firms cost of capital.Net present value therefore considers time value of money by taking in to consideration the effects of inflation on the value of money due to passage of time before its received. Net present value can thus be said to the present value of all cash inflows and outflows from a project discounted with a rate which is determined after putting into consideration the risk profile of a project or business venture (Arshad, 2012).
According to Arshad (2012) Net present value actually calculates the amount of money in excess of the initial investment outlay from discounting future inflows with a firm’s average cost of capital. The decision criterion is that if the net present value is greater than 1 (one) the firm should accept the investment but if it is less than 1 (one) the firm should reject the investment opportunity. For mutually exclusive projects therefore a firm should only accept those projects with a net present value of more than 1 (one) and reject those with a net present value of less than 1(one). The general rule is that the bigger the net present value figures the better for investment purposes. The project with the largest net present value should be selected over the one with a smaller net present value figure.
In the case below Google is considering investing in a new project or business opportunity that will have initial cash outflow (cost) of $1,750,000. In this case Google’s cost of capital is 14%. The project is expected to bring in future cash flows as shown in the table below.
| Year | Cash in flow | Present value of Cash inflows |
| 0 | -$1,750,000 | -$1,750,000 |
| 1 | 350,000 | 307,017.54 |
| 2 | 630,000 | 484,764.54 |
| 3 | 700,000 | 472,480.06 |
| 4 | 550,000 | 325,644.15 |
| 5 | 850,000 | 441,463.36 |
| Net Present Value of the investment | $281,369.66 | |
In order to calculate the project’s net present value we start by calculating the present value of the cash inflows.
Present Value (PV) of Cash Flows (CF) = CF1 / (1+r)1 + CF2 / (1+r)2 + CF3 / (1+r)3 + CF4 / (1+r)4 + CF5 / (1+r)5…… CFn / (1+r)n
Whereby;
PV=Present value
CFn= Cash flow to be received in period n
r=Discount rate
n- Time period with which the cash inflows will be received
Calculations
In year 0 the present value is equal to initial capital outlay.
Present Value (PV) in year 1 =>PV =350,000 / (1+0.14)^1
=>350,000 / 1.14 = 307,017.54
Present Value (PV) in year 2=> PV = 630,000 / (1+0.14)^2
- 630,000 / (1.14)^2 => 630,000 / 1.2996 = 484,764.54
Present Value (PV) in year 3=>PV=700,000 / (1+0.14)^3
- 700,000 / 1.481544 = 472,480.06
Present Value (PV) in year 4=>550,000 / (1+0.14)^4
- 550,000 / 1.68896016 = 325,644.15
Present Value (PV) in year 5=>850,000 / (1+0.14)^5
- 850,000 / 1.925414582 = 441,463.36
Net present value therefore is total present value of cash inflows less initial capital outlay (cost)
Hence Net Present Value (NPV) of Google’s new proposed project is as follows
- $2,031,369.66 – $1,750,000 = $281,369.66
Based on the foregoing analysis the project has a net present value of = $281,369.66 which is more than 1 (one). The decision criterion in net present value concept is that if a project has a net present value of more than 1 (one) it can be accepted but if it has a net present value of less than 1 (one) it should be rejected. It would therefore make a wise investment decision for Google’s shareholders and executives to invest in the new proposed project.
PART II
1.) Analysis on whether Google’s potential acquisition of Groupon would add value to the shareholders of both corporations
The acquisition of Groupon, which runs a daily deals website, by Google would benefit the shareholders of both firms in several ways. During negotiations of the deal, Groupon benefited from association with Google for its revenues increased tremendously and its reputation in the market greatly improved (Winkler, 2010). In 2010, Groupon’s sales revenue surged to $760 million compared to $33 million realized in the previous year of 2009. The market price of Groupon also rose tremendously which increased the shareholder wealth. In this scenario the shareholders of both companies are likely to receive high dividends and also would make capital gains if they sold their shares in the securities exchange (Efrati, 2011). It also appears from the revenues earned that the market was supporting the deal. Groupon’s shareholders would have received higher capital gains than they would have realized had the deal not been there. After the deal collapsed Groupon chose to go public and its value fell by 79% to $2.8 billion from the $6 billion Google was offering (Wall Street Journal, 2011). In this case the shareholders of Groupon lost value instead of making capital gains had the deal been sealed with Google.
If the acquisition went through Groupon’s shareholders would also have benefited from the increased market reach of its products since Google has a better marketing infrastructure (Winkler, 2010). The sales revenue of Groupon would have rose to new levels which would have seen Groupon’s shareholders make phenomenal capital gains. Groupon’s shareholders seems to have lost more than Google’s shareholders since after the deal collapsed Groupon’s sales fell drastically, In fact in the fourth quarter of 2011 the revenues were restated to $14.3 million which was a six fold drop from the deal year of 2010 (Efrati, 2011). The sudden drop in revenues was because the allure of daily-deal websites which is Groupon’s core business activity was wearing off among consumers. Groupon is also facing intense competition from the ever increasing number of competitors. Had the deal gone through Groupon would have leveraged the competitive advantage that Google has achieved in the market to grow its revenues. Google’s shareholders would have benefited by increasing the value of their shareholding by $6billion dollars (Winkler, 2010). Google shareholders would also increase the number of product lines that Google is currently managing and this would have brought in more returns which would have translated to higher dividend payout at the end of the financial year. In general Google’s shareholders will benefit from Groupon acquisition by getting new technology, talented engineers and an increase in revenue base from the new product line. Groupon’s shareholders will benefit from access of extra capital to support its rapid growth which will enable it achieve its sales growth targets (Efrati, 2011).
2) Recommendations to the shareholders of Google and Groupon based on my analysis and findings (Part I and Part II)
According to the foregoing analysis, the shares of Google would have risen in the market had the deal gone through. This would have increased the value of Google’s shares and enabled the shareholders of the two companies to make huge capital gains. The two companies should conclude the deal since it has positive net present value (NPV) of $281,369.66, which is more than 1 (one). The business venture would bring in positive returns which would grow the asset base of both companies (Efrati, 2011). Google will also benefit by combining a potential competitor and Groupon would benefit by utilising the huge and more popular Google’s search engine to increase its sales revenue (Winkler, 2010). There will be synergies that will be generated by the deal which will grow the value of the two companies. Benefits to Google’s shareholders would include adding a new product line which would definitely grow Google’s sales revenues by a substantial percentage. The other benefit to Google would be that it will add into its existing staff establishment a pool of talented and competent staff mainly drawn from the technical field. Google would also take over all staff member of Groupon which would definitely increase Google’s skill base and enhance its competitive position in the market (Winkler, 2010). Google would then leverage this new knowledge for the benefit of existing business and the new business to be brought on board by the acquisition (PR Newswire, 2011).
The risk factors in this deal include a possible drop in Groupon’s revenues due to the customers are fast losing interest in web based deals which is Groupon’s core business. This could lead to drastic fall in sales revenues which would lead to loss in value. Google would also be entering into unfamiliar business facing intense competition which would likely lead to a fall in revenues instead of rising. Google may therefore be unable to recover the money spent in acquiring Groupon (Efrati, 2011).
The other risk is foreign currency risk. Since Groupon generates a large part of its revenues from overseas markets that would increase foreign currency risk. Unexpected and drastic fluctuation in foreign currency exchange rate would seriously affect the revenues from Groupon’s product line. The other risk is associated with operational challenges in terms of being more efficient than the competition (Efrati, 2011). The other risk is liquidity related. Due to intense competition in Groupon’s line of business, Google’s could lose its money instead of gaining in terms of revenues. The business also faces management risk in that Google did not have management and operational expertise in Groupon’s business. If top managers of Groupon left then the business operations of the new line of business would most likely be grounded to a halt (http://www.bloomberg.com/news/2012-12-11/buying-groupon-hard-for-anyone-as-growth-slows-real-m-a.html?link=mktw)
.
References
Advisers vie to take on groupon IPO. (2011, Jan 14). Wall Street Journal (Online). Retrieved from http://search.proquest.com/docview/839609105?accountid=45049
Arshad, A. (2012). Net present value is better than internal rate of return. Interdisciplinary Journal of Contemporary Research in Business, 4(8), 211-219. Retrieved from http://search.proquest.com/docview/1282292585?accountid=45049
Efrati, A. (2011, Mar 05). Google cranks M&A machine — undaunted by valuations, deals chief says will continue to pursue start-ups.Wall Street Journal. Retrieved from http://search.proquest.com/docview/855035294?accountid=45049
Google acquisitions and strategy. (2011, Dec 22). PR Newswire. Retrieved from http://search.proquest.com/docview/912248654?accountid=45049
http://www.bloomberg.com/news/2012-12-11/buying-groupon-hard-for-anyone-as-growth-slows-real-m-a.html?link=mktw
Winkler, R. (2010, Dec 01). No groupon discount for google.Wall Street Journal. Retrieved from http://search.proquest.com/docview/814956094?accountid=45049
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