200611801956188

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Project Training
MS Training
July 2001
MORGAN STANLEY DEAN WITTER
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Table of Contents
Section 1
Overview
Section 2
Morgan Stanley Financial Definitions
Section 3
Market-Based Valuation
Tab A
Comparable Companies Analysis
Tab B
Precedent Transactions Analysis
Section 4
Intrinsic Valuation
Tab C
Discounted Cash Flow Analysis
Section 5
Merger Accounting/Analysis
Tab E
Accounting Issues
Tab F
Contribution Analysis
Tab G
Mini-Merger Analysis
Tab H
Value Creation Analysis
Tab I
Potential Impact of New Accounting Rules
Tab J
Overview of Former Accounting Practices
Section 6
Restructuring
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Table of Contents (cont'd)
Section 7
Equity Capital Market Services
Section 8
Fixed Income Capital Markets (FICM)
Section 9
Case Studies
Tab K
Ziff-Davis
Tab L
UPS
Tab M
APA Merger
Tab N
Real Estate
Tab O
American General
Tab P
AOL Time Warner
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Section 1
Overview
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Overview
Valuation Overview
Morgan Stanley uses four
primary valuation techniques
to establish the value range
for a company
Comparable
Company
Trading
Analysis
Precedent
Transaction
Analysis
Company Value
Leveraged
Buyout Analysis
Discounted
Cash Flow
Analysis
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Overview
Summary of Valuation Techniques

There is no single correct
valuation technique.
However, each approach has
strengths and weaknesses
and should be used in the
context of each specific
situation
Valuation Method
Comparable Company
Trading Analysis
Generally several valuation

techniques are used to
determine a value range
Description
Comments
Provides Companys implied value in the public

equity markets through analysis of comparable
companies trading and operating statistics
Reliability depends on the level of comparability of

other publicly traded companies
industry
Does not include control premium
range of products
Fully distributed trading value
revenue base (size)
Apply multiples derived from similar or comparable

publicly traded companies to companys operating
statistics
geographical presence
profitability
growth
A change of control premium may be applied to
estimate private market value
Precedent Transactions
Analysis
Provides private market benchmark in a change of

control scenario
Does include control premium
Reliability depends on number of recent precedent

transactions and their degree of comparability, as
well as the relative supply and demand for a certain
type of asset at the time of the transaction
Apply multiples derived from similar or comparable

Market cycles and volatility may also affect
precedent M&A transactions to Companys
valuation
operating data
Discounted Cash Flow
Analysis
Theoretical valuation
Leveraged Buyout Analysis
Determine the range of prices that a financial buyer

would be willing to pay for an asset assuming a
range of target rates of return
This analysis is heavily dependent on the cash flow

profile of the asset exit value assumption
Other
Check if there are any other sources of value in a

particular transaction
Different valuation techniques might apply
Project the Companys future operating cash flows

for five years or more and calculate the present
value of those cash flows and of the terminal value
using an appropriate cost of capital and terminal
value methodology
This analysis is heavily dependent on cash flow and

growth characteristics of the company, and the
terminal value assumption
Net operating loss carryforwards (NOLs)

Synergies
Off balance sheet items
Break-up value
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Overview
Applications of Valuation Techniques

Valuation analysis is central to the advice Morgan Stanley gives its clients and is used broadly
throughout the firm
Applications of valuation analysis include:
Acquisitions
How much would one be willing to pay to buy the company?
Divestitures
How much can the company/division be sold for?
Fairness Opinion
Is the price offered for the company/division fair from a financial point of view?
Public Equity Offerings
How much value can be obtained in the public market for the company/division?
Restructurings
What is the value that can be generated through a restructuring of the company?
New Business Presentations
Various applications
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Section 2
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The Basic Equations
AV
= EV + Net D or EV = AV - D
EV
= NI x P/E
NI
= (EBIT - Int. Exp.) (1 - t)
Int. Exp
=Dxr
= L% * AV
Definitions:
AV
= Asset value
EV
= Equity value (market)
= Debt (net)
P/E
= Price to earnings ratio (= price per share/earnings per share)
NI
= Net income
EBIT
= Earnings before interest and taxes
= tax rate
= interest rate
L%
= D/(D + EV), or leverage
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Dynamic Model Overview

Relationships Between Key Financial Statements
Balance Sheet
Income Statement
Sales (driver: growth)
- Cost of Goods Sold
Cash
+
Inventory
Accounts Receivable
- Operating Expenses (driver: margin, inflation)
PP&E
+ Synergies (if any)
Total Assets
Accounts Payable
Debt
Shareholders Equity
= Gross Profit (driver: margin)
= EBIT
- Interest
= EBT
- Tax
Cash Flow Statement
Change in Inventory (driver: turns/sales)
Net Income
Change in Accounts Receivable (driver: days/sales)
+ Depreciation (1)
Change in Accounts Payable (driver: days/COGS)
= Operating Cash Flow
- Investment in WC
- Capital Expenditures
= Free Cash Flow
+/-Change in Debt
- Dividend Payments
Total Liabilities and Shareholders Equity

Working Capital Schedule
= Net Income
Investment in WC
Debt and Cash Schedule
Beginning Cash Balance
Beginning Debt Balance
+/- Change in Cash

+/- Debt paydown/increase
+/-Change in Equity
Ending Debt Balance (calculate interest expense on average)
= Change in Cash
Ending Cash Balance (calculate interest income on average)
Note
1. Depreciation of factory-related items can be found in Cost of Goods Sold. Depreciation on everything else (headquarters, copiers in corporate offices, etc.)
can be found in SG&A
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Mechanics of Dynamic Model
Income Statement
Financial Statement
Comments
Sales
Sales are driven by sales growth assumptions
% Sales Growth
Formula: Sales = Last Year Sales x (1 + Current Year Sales Growth)

Sales Growth = Input on Assumption Page
Cost of Goods Sold (COGS)
COGS are driven by margin assumption
% COGS Margin
Formula: COGS = Sales x COGS Margin

COGS Margin = Input on Assumption Page
Gross Profit
Formula:
% Margin
Operating Expenses
Operating Expenses are driven by % of sales assumptions
% of Sales
Formula: Operating Expenses = Sales x % of Sales

% of Sales = Input on Assumption Page
EBITDA
Formula:
% Margin
EBIT
% Margin
Net Interest Expense
EBT
% Margin
EBITDA = EBIT + Depreciation
Margin = EBIT / Sales

Formula:
EBIT = Gross Profit - Operating Expenses
Margin = EBIT / Sales

Interest Expense is driven by interest rate assumptions
Formula:
Interest Expense = Average Debt x Interest Rate
Formula:
EBT = EBIT - Net Interest Expense
Margin = EBT / Sales
Taxes
Taxes are driven by assumed tax rate
% Tax Rate
Formula: Taxes = EBT x Tax Rate

Tax Rate = Input on Assumption Page
Net Income
Formula:
% Margin
Cash Flow Statement
Gross Profit = Sales COGS
Margin = Gross Profit / Sales
Net Income = EBT - Taxes
Margin = Net Income / Sales
Net Income
Read from Income Statement
Depreciation
Calculated based on % of PP&E
% of PP&E
Formula: Depreciation = PP&E at beginning of year x % of PP&E

% of PP&E = Input on Assumption Page
Other Non-Cash Items
Keep constant from historical results or make specific assumptions as needed
Investment in Working Capital
Read from change in working capital provided by working capital schedule
% of Change in Sales
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Mechanics of Dynamic Model (contd)
Cash Flow Statement (contd)
Financial Statement
Comments
Operating Cash Flow
Formula:
% of Sales
Selected Balance Sheet Items
Operating Cash Flow = Net Income + Depreciation + Other Non Cash Items
% of Sales = Operating Cash Flow / Sales
Capital Expenditure
Calculate based on % of average PP&E or on % of Depreciation or on % of Sales
% of PP&E
Formula: Capital Expenditures = Average PP&E x % of [PP&E]

% of [PP&E] = Input on Assumption Page
Levered Free Cash Flow
Formula:
Levered Free Cash Flow = Operating Cash Flow Investment in Working Capital - Capital Expenditure
After Tax Interest Expense
Formula:
After Tax Interest Expense = Net Interest Expense x (1 - Tax Rate)
Unlevered Free Cash Flow
Formula:
Unlevered Free Cash Flow = Levered Free Cash Flow + After Tax Interest Expense
Working Capital Schedule

Accounts Receivable
Calculated based on days receivable
Days Receivable
Formula:
Accounts Receivable = Sales x (Days Receivable / 365)
Days Receivable = Input on Assumption Page

Inventory
Calculated based on inventory turnover
Inventory Turnover
Formula: Inventory = COGS / Inventory Turnover

Inventory Turnover = Input on Assumption Page
Other Current Assets
Calculated based on % of Sales
% of Sales
Formula: Other Current Assets = Sales x % of Sales

Accounts Payable
Calculated based on days payable
Days Payable
Formula: Accounts Payable = COGS x (Days Payable / 365)

Days Payable = Input on Assumption Page
Other Current Liabilities
Calculated based on % of Sales
% of Sales
Formula: Other Current Liabilities = Sales x % of Sales

Net Working Capital
Formula:
Liabilities
% of Sales
Change in Net Working Capital
% of Change in Sales
Net Working Capital = Accounts Receivable + Inventory + Other Current Assets Accounts Payable - Other Current
% of Sales = Net Working Capital / Sales

Formula:
Change in Net Working Capital = Current year Net Working Capital - Last Year Net Working Capital
% of Change in Sales = Change in Net Working Capital / Change in Sales
PP&E Schedule
PP&E
Start with latest Balance Sheet entry (see 10Q/10K)

Formula:
PP&E = Last Year PP&E + Capital Expenditures - Depreciation
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Morgan Stanley Definitions
Financial Term
Definition
Income Statement
Sales (Revenues)
In general, revenue is recognized, not as goods are produced nor as orders are received, but only when the sale (delivery) has been consummated and cash or a
receivable is obtained. In certain circumstances other recognition methods may be used (e.g., percentage-of-completion method, installment method)
Cost of Goods Sold (Cost of Sales)
Inventoriable costs that firms expense because they sold the units; equals beginning finished goods inventory plus cost of goods purchased or manufactured minus
ending finished goods inventory
Gross Profit
Sales minus Cost of Goods Sold
Operating Expenses
Expenses incurred in the course of ordinary activities of an entity excluding Cost of Goods Sold, Interest and Income Tax Expenses. In general Operating Expense
include items such as Labor, Energy, Selling, General & Administrative, Depreciation & Amortization
Earnings Before Interest, Income Taxes, Depreciation and Amortization (EBITDA)
EBIT plus Depreciation & Amortization; adjust for Extraordinary Items such as Restructuring Charges
Earnings Before Interest and Income Taxes (EBIT)
Gross Profit minus Operating Expenses; adjust for Extraordinary Items such as Restructuring Charges
Interest
The charge or cost of using money, usually borrowed funds: For calculation, Morgan Stanley applies the interest rate to the average amount of debt outstanding
Nominal Interest Rate: a rate specified on a debt instrument, which usually differs from the market or effective rate. Also, a rate of interest quoted for a year (If the
interest is compounded more often than annually, then the effective interest rate is higher than the nominal rate)
Effective Interest Rate: for bond, the internal rate of return or yield to maturity at the time of issue (contrast with coupon rate) (e.g., if the bond is issued for a price
below par, the effective rate is higher than the coupon rate). In the context of compound interest, the effective interest is the single rate that one could use at the
end of the year to multiply the principal at the beginning of the year and give the same amount as results from compounding interest each period during the year
Coupon Rate: for bond, the amount of annual coupons divided by par value (contrast with effective rate)
Gross Interest Expense: interest incurred before subtracting Interest Income
Net Interest Expense: Gross Interest Expense minus Interest Income
Earnings Before Taxes (EBT)
Difference between all revenues and expenses except income tax expense
Income Tax
Annual tax levied by the federal and other governments on the income of an entity
Effective Tax Rate: Income Tax Expense divided by EBT; average rate paid for certain period
Marginal Tax Rate: Tax rate paid on the incremental dollar of income
Minority Interest
The minoritys interest in current periods income of a subsidiary between 50% and 100%; must be subtracted to arrive at consolidated net income for the period
Net Income (available to common shareholder)
Net Income before Extraordinary Items and after Minority Interest and Preferred Dividends
Earnings per Share (EPS)
See below for more detail
Writing off the cost of an asset (the accounting process of reducing an amount by periodic payments or write-downs)
Cash Flow Statement

Depreciation
Depreciable Life: the time period or units of activity (such as miles driven for a truck) over which depreciable cost is to be allocated. Far tax purposes, depreciable
life may be different than for accounting purposes
Amortization
Depreciation of intangible assets (e.g., Goodwill)
Depletion
Depreciation of wasting assets (natural resources)
Deferred Taxes
Timing difference in Taxes based on different accounting principles in tax returns from those used in financial reports
Operating Cash Flow
Sum of Net Income available to common shareholders, Depreciation, Depletion and Amortization, Deferred Taxes and other non-cash expenses less any non-cash
revenues
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Morgan Stanley Definitions (contd)
Financial Term
Definition
Investments in Working Capital
Net Change in Working Capital accounts over accounting period (see Working Capital definitions)
Capital Expenditures
Expenditures to acquire long-term assets
Operating Cash Flow less Capital Expenditures and less Investments in Working Capital
Levered Free Cash Flow plus after tax Net Interest Expense
Cash Flow per Share
Operating Cash Flow divided by the weighted average common shares outstanding
Working Capital
Accounts Receivable (Receivables)
Collectibles due within one year
Receivable Days Outstanding: 365 multiplied by average Accounts receivable divided by Sales
Inventory
Other assets the firm expects to turn into cash, sell, or exchange within one year
Accounts Payable (Payables)
Amounts due to suppliers within one year
Obligations that a firm must discharge within one year
Net Working Capital
Current Assets (incl. Accounts receivables, Inventory, Other Current Assets) minus Current Liabilities (incl. Accounts Payable, Other Current Liabilities)
Balance Sheet
Statement of financial position at one point in time: Shows Total Assets = Total Liabilities + Shareholders Equity
Cash
Currency and coins, negotiable checks and balances in bank accounts
Marketable Securities
Stocks and bonds of other companies held that can be readily sold on stock exchanges and that the company plans to sell as cash is needed. The same securities
held for long-term purposes would be classified as Noncurrent Assets. Accounting rules require lower-of-cost-or-market valuation for all marketable equities but
different accounting treatments depending upon whether the security is a current or a noncurrent asset
Accounts Receivable
See Working Capital definitions
Inventory
Property, Plant and Equipment (Fixed Assets)
Assets used in Revenue production process, including buildings, machinery, equipment, land, and natural resources
Intangible Assets
A nonphysical, noncurrent right that gives a firm an exclusive or preferred position in the market place. Examples are copyright, patent, trademark, goodwill,
organization costs, capitalized advertising costs, computer programs, licenses, leases, franchises, mailing lists, exploration permits
Goodwill
The excess of cost of an acquired firm (or operating unit) over the current fair market value of the net assets of the acquired unit
Total Assets
Sum of all Assets appearing on Balance Sheet
Accounts Payable
Short-Term Debt
Notes payable, current portion of Long-Term Debt and bank borrowings; Payable within one year
Raw materials, supplies, work in process, and finished goods
Inventory Turnover: Cost of Goods Sold divided by average Inventories
Payable Days Outstanding: 365 multiplied by average accounts payable divided by cost of goods sold
Balance Sheet
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Financial Term
Definition
All senior, subordinated, convertible, mortgage and bank Long-Term Debt (leases capitalized under FASB #13 are included in Long-Term Debt); payable after more
than one year
Capitalized Leases
The present value of Capital or Finance Leases that should be or are on the balance sheet under FASB #13
Operating Leases
Estimated by: Gross Rent expenses multiplied by eight
Pension Liabilities (Unfunded)
The difference between the present value of all vested benefits owed in the future and the value of the pension assets
Preferred Stock
Capital stock with a claim to income or assets after bondholders but before common shareholders
Minority Interest
Equity in less-than-100-percent-owned subsidiary companies allocable to those who are not part of the controlling interest
Shareholders Equity (Book Value of Equity)
Sum of Common Stock, Capital Surplus and Retained Earnings less Treasury Stock
Book value per Share
Shareholders Equity divided by common shares outstanding
Total Debt
Sum of Short-Term Debt plus Long-Term Debt plus Minority Interest plus Preferred Stock
Net Debt
Total Debt less Cash and Cash Equivalents (i.e., Marketable Securities)
Book Capitalization
Sum of Long-Term Debt plus Minority Interest plus Preferred Stock and Shareholders Equity
Adjusted Book Capitalization
Book Capitalization plus Short-Term Debt
Total Capital
Sum of Short-Term Debt, Long-Term Debt, Minority Interest, Preferred Stock and Shareholders Equity
Price per Share
Current Market Price (for presentations use the closing price of defined date)
Unaffected Price Per Share
Most recent closing share price prior to specific announcement (i.e., announcement of strategic activity, earnings); for PPAIDS, unaffected price is normally assumed
to be 30 days prior to the transaction announcement
Market Value (Equity Value)
Common Stock outstanding multiplied by the Current Market Price Per Share
Market Capitalization
Market Value plus Long-Term Debt plus Minority Interest plus Preferred Stock (should not be used)
Adjusted Market Capitalization
Market Capitalization plus Short-Term Debt (should not be used)
Aggregate Value
Adjusted Market Capitalization less Cash and Cash Equivalents
Long-Term Debt
Market Valuation
Ratios and Statistics

Operating Statistics
Financial Leverage Ratios
EBITDA Margin (EBITDA/Sales)
EBIT Margin (EBIT/Sales)
Net Income Margin (Net Income/Sales)
EPS Growth (Next five years EPS CAGR, get from FactSet)
(Long-Term Debt plus Minority Interest plus Preferred Stock)/Book Capitalization
Total Debt/Adj. Book Capitalization
The above ratios can also include capitalized leases and off-balance sheet items
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Financial Term
Debt Service Ratios
Interest Coverage Ratios
Return Statistics
Definition
Operating Cash Flow/Long-Term Debt
Operating Cash Flow/Total Debt
Free Operating Cash Flow/Total Debt
Total Debt/EBITDA
Total Debt/EBITDA (including Rents)
EBITDA/Gross Interest Expense
EBIT/Gross Interest Expense
Operating Cash Flow/Gross Interest Expense
Free Operating Cash Flow/Gross Interest Expense
Pre-Tax Return on Capital (EBIT divided by average Total Capital)
After-Tax Return on Capital (Net Income divided by average Total Capital)
Return on Equity (Net Income divided by average Shareholders Equity)
Pre-Tax Return on Assets (EBIT divided by average Total Assets)
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Summary of Basic and Diluted EPS Calculations

Summary of Basic and Diluted EPS Calculations
Basic Earnings Per Share

Weighted Average Basic Shares Outstanding
Net Income
to Common
Shareholder
Includes only shares outstanding during

relevant period
Does not include any potentially dilutive
securities
Diluted Earnings Per Share

Diluted Net Income
Net income to common shareholders + after tax
interest expense or preferred dividends related
to dilutive convertible securities, if any
Shares from Convertible Securities (if

Converted)
Weighted
Average
Basic Shares
Outstanding
Includes shares from the conversion of

convertible securities only if they will be dilutive
to EPS upon conversion, i.e., the dilutive impact
of underlying shares exceeds the effect of the
addback of asociated interest expense
Options and Warrants (Treasury Stock

Method)
Treasury Stock Method
Includes shares from all outstanding warrants

and options only if they will be dilutive to EPS
upon exercise, i.e., the average market price for
the relevant period exceeds the exercise price
Increase the number of the basic shares
according to the treasury stock method
The treasury method assumes that the proceeds form the

exercise of warrants and options are used to repurchase
shares at the average market price for the relevant period
Treasury shares are calculated as follows: (Average
Market Price for Period - Exercise Price) X Warrant &
Option Shares Average Market Price for Period
Diluted shares outstanding differ in accounting and acquisition context

Weighted Average Shares Outstanding used to
calculate Basic Earnings per share and Diluted
Earnings per share are accounting concepts that
allow for the allocation of net income to a
hypothetical number of shares outstanding over a
given period of time
However, in the context of an acquisition, an acquiror

is concerned with the purchase of all of the targets
equity securities (including those that represent
underlying equity e.g., options, warrants,
convertibles) outstanding at the time of the
acquisition
Used to facilitate comparisons between different

companies and calculation of relationship between
earnings and stock price
Stated differently, if an acquiror seeks to purchase

100% control of a target, consideration must be
given to all securities with potential equity rights
Specific rules regarding the inclusion/exclusion of

potentially dilutive securities
Therefore, for acquisition analysis, it is necessary

to assume that all outstanding instruments with
underlying in-the-money equity value are
converted
For acquisition analysis, fully diluted number of

shares outstanding is calculated based on the latest
publicly disclosed number of common shares
outstanding (stated on front of latest 10-Q or 10-K for
U.S. companies) and the latest available information
regarding outstanding warrants, options and
convertible securities (generally found in financial
statements in latest 10-K)
In making adjustments to number of shares
outstanding, be certain to (i) include proceeds from
the assumed exercise of any options or warrants
and (ii) adjust the income statement to exclude
after-tax amount of interest expense or preferred
dividends associated with convertible securities
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Section 3
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Tab A
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Comparable Company Analysis

Overview
Uses
Public market valuation of publicly traded company (e.g., is the company undervalued? Why?)
Establish public market valuation benchmarks for private company
Analysis of the break-up value of a conglomerate by establishing public market valuation
benchmarks for each business segment
Allows benchmarking of operating performance
Yields fully-distributed equity value of the company/division
Advantages
Disadvantages
Based on public information
Difficult to find large sample of truly comparable companies;

it is difficult/impossible to adjust for differences in the
underlying business of comparable companies
Despite market efficiency arguments, sometimes difficult
to explain different valuations and trading levels for
apparently similar companies
Trading valuation of a company may be affected by thin
trading activities, small capitalization, poor research coverage,
and small public float
Argument that the market can be wrong
Stock prices may be impacted by outside variables such as
M&A activity in the sector, regulatory scrutiny, etc.
Market efficiency implies that, in theory, trading valuation

should reflect all available information including trends,
business risk, growth characteristics, etc.
Values obtained can be reliable indicator of the value of the
company for a minority investment (i.e., does not include
control premium)
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Comparable Company Analysis

Purpose
Compare all publicly traded companies in one industry according to:

Trading value
Financial performance
Credit profile
Identify relative value among:
Publicly traded companies
Operating units of a large corporation
Indicate credit profile to:
Determine credit rating
Determine appropriate capital structure
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What Are You Analyzing?

How should this company be valued?
Different industries trade on different multiples
Multiples are consistent within an industry
Relevant multiple range
Relative value of the company compared to relevant industry multiple range
How does the companys operating and financial profile compare up to its peers?
Industry-specific trends
Growth prospects
Operating margins
Capital structure
Questions to ask yourself:
What companies should I compare this company or operating unit to?
What multiples should I be looking at?
Does this company trade at a discount or premium to its peers? If so, why?
How efficient is the companys operating model relative to its peers?
What kind of credit rating should this company receive?
How does this companys capital structure compare to those of its peers?
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Selecting Comparable Companies

Step 1: Identify Comparable Companies
Step 2: Identify Valuation Benchmarks
Step 3: Gather Data
Business characteristics
Financial benchmarks
Industry group
Products
Determined by industry
Product Mix
Determined by growth phase
Geographical markets
Customers
Financial characteristics
Size (revenues, operating income)
Industry-specific benchmarks
Research reports
Key statistics for industry
10K: Competition section
e.g., Internet: Agg. Val/Users
Bloomberg
Calculate mean and median values
Profitability (operating margins)
Median values are standard
Leverage
Mean values are included but are often

skewed due to outliers
Rank according to relevance
FACTSET/SIC run
Equity research
Tier I: Pure-play
Tier II: Relevant
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Output
Trading
Operating
Credit
Compare multiples based on companies

trading values
Analyze companies past and projected

financial performance
Determine credit profile and implied

credit rating
Uses:
Identify correlation between trading and

operating statistics
Indicates optimal capital structure
Valuation range
Identify undervalued companies
Identify key industry players
Identify acquisition targets
Key Features:
Equivalent fiscal year-end mean and
median calculations
e.g., high growth rates equate to

high trading multiples
Appropriate amount of leverage

Typical Ratios:
Relative measure of companies

operating efficiency
Debt/Book Capitalization
Uses:
Debt/EBITDA
Debt/Market Capitalization
Identify companys competitiveness
EBIT/Interest
Identify industry trends
EBITDA/Interest
Identify cyclicality
Cash Flow/Total Debt
Identify areas for improvement
Cash Flow Cap Ex/Total Debt
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Equity vs. Aggregate Value

Equity Value
Aggregate Value
Shares outstanding x Current stock price
Equity Value + Net Debt
Market value of a companys equity

Represents flows available to holders of
equity after debt and preferred claims have
been serviced
Typical equity value multiples:
Equity value/Net Income (P/E)
Equity value/After-tax Cash Flow
Equity value/Book Value of Equity
Net Debt = Short-term Debt + Long-term

Debt + Minority Interest + Preferred
Stock + Capitalized Leases - Cash and
Cash Equivalents
Represents value available to service
claims of all investors, including holders of
both debt and equity securities
Typical aggregate value multiples:
Aggregate Value/Revenue
Aggregate Value/EBITDA
Aggregate Value/EBIT
Aggregate Value/Free Cash Flow
Other terms for Aggregate Value:
Asset Value
Total Value
Firm Value
Enterprise Value
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Calendarization
EPS calendarization always want to look at forward looking statistics, like EPS estimates, on
apples to apples basis
If one companys year-end is January 31 and anothers is September 30, we need to adjust EPS
estimates to include the same earning periods
I/B/E/S EPS estimates for CoA: $1.60 for the first year, $1.90 for the second, for the years
ending 11/30 we want to look at them on 12/31 basis
If the year-end for analysis purposes is 12/31, 11 months will have passed during year in
which the earnings estimate was $1.60, so take 11/12 of that number
Only one month remains in year which earnings estimate is $1.90, so take 1/12 of that number
Result is a weighted average of $1.63 for the year ending 11/30
19
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Project Training
Latest Twelve Months (LTM) Calculation

Assumptions
LTM Sales
Fiscal Year End
9/30/00
Quarter End
6/30/01
Sales (Annual) ($)
$200 + $170 - $120 = $250
(1)
200
Sales (9 Months Ended 6/30/01)
170
Sales (9 Months Ended 6/30/00)
120
Graph Heading
Y Axis9/30/99
Label Heading
6/30/00
9/30/00
6/30/01
Last Twelve Months
$200
$120
Note
1. For the year ended 9/30/99
$170
20
NYIBDF13\162526\A2\11 JUL 2001\6:53 AM\29
Project Training
EPS Calendarization Calculation

Assumptions
12/31/00 Calendarized EPS
Last Fiscal Year End
11/30/00
Calendarization Date
12/31/00
EPS Year Ended 11/30/00 ($)
1.60
1.90
11
/12 ($1.60) + /12 ($1.90) = $1.63
Graph Heading
Y Axis11/99
Label Heading
12/99
11 Months
$1.60
11/00
12/00
11/01
1 Month
$1.90
21
NYIBDF13\162526\A2\11 JUL 2001\6:53 AM\30
Project Training
EPS Calendarization Calculation

Continued
Assumptions
1/31/01 Calendarized EPS
Last Fiscal Year End
11/30/00
Calendarization Date
1/31/01
1.60
1.90
10
/12 ($1.60) + /12 ($1.90) = $1.65
Graph Heading
Y Axis11/99
Label Heading
1/00
10 Months
$1.60
11/00
1/01
11/01
2 Months
$1.90
22
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Project Training
Asset Value vs. Equity Value

Concept
Return on the Companys Assets
Use Asset Value

Multiple
Available to all
providers of capital
Sales
EBITDA
EBIT
Use Equity Value

Multiple
Available to equity
providers only
EBT
Net Income
Free Cash Flow
Financing of the Companys Assets
Debt
Equity
Company Data
Example
CoB(2)
$
Sales
6,298
6,298
EBIT
1,024
1,024
Implied Valuation Multiples
128
Aggregate Value/Sales (x)
1,024
896
Aggregate Value/EBIT (x)
Tax (36%)
369
323
Equity Value/Net Income (x)
Net Income
655
573
Return on Equity (%)
Asset Value
9,300
9,300
1,903
9,300
7,397
Interest
EBT
Net Debt
Market Value of Equity
Valuation Analysis
CoA(1)
$
Notes
1. Unlevered (no debt)
2. Levered (with debt)
Example
CoA(1)
CoB(2)
Asset Value ($)
9,300
9,300
Equity Value ($)
9,300
7,397
1.5
1.5
9.1
9.1
14.2
12.9
7.0
7.8
23
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Project Training
Specific Calculations for Comparables Analysis

Adjusting for Non-Recurring Items
Example
Sales
Gross Profit
SG&A
Original Adjustment
100
100
50
50
30
30
10
EBIT
10
(10)
0
20
Interest
Expense
EBIT
15
Taxes (40%)
Net Income
Comments
Example
Sales
LTM Sales
Comments
Restructuring
Charge
Calendarizing
LTM Calculation
Adjusted
Footnotes to financial
statements often provide the
net-of-tax effect of nonrecurring items
12/31/99
10K
100
6/30/99
10Q
6/30/00
10Q
48
54
100 + 54 - 48 = 106
Be careful when
calculating LTM EPS as
the number of shares
might have changed
Use weighted average
shares outstanding
applied to the LTM net
income
EPS
Fiscal
Year End
LFY
FY1
CoA
12/31
3.30
3.68
CoB
1/31
2.15
2.35
Example
Calendarize Company B to 12/31:

1
/12 x 2.15 +
11
/12 x 2.35 = 2.33
Quick Check: Result must lie between LFY

and FY1 EPS
Comments
Always try to
calendarize companies
to acquiror year- end
(unless industry
standard exists)
Be particularly careful
when analyzing highly
cyclical industries
Also applicable to the
Mini Merger Model
24
NYIBDF13\162526\A2\11 JUL 2001\6:53 AM\33
Project Training

Trading Statistics
Comparable Companies
Price/Earnings
Revenue
Aggregate Value/
EBIT
EBITDA
5-Yr.
Price/
EPS
Book CAGR
x
%
2002E
P/E to
Growth
x
Compa
ny
Current
Price
$
Market
Val.
$MM
Agg. Val.
$MM
01E
x
02E
x
LTM
x
01E
x
LTM
x
01E
x
LTM
x
01E
x
CoA
40.350
18,324
21,600
18.1
16.1
2.7
3.1
12.0
14.6
10.2
12.3
12.3
12.7
1.3
CoB
22.450
10,785
16,198
16.0
14.4
0.7
0.7
12.2
11.4
9.2
8.6
3.4
13.0
1.1
CoC
38.050
10,988
13,663
17.1
15.2
1.6
1.6
12.1
11.1
9.8
9.1
9.1
11.8
1.3
CoD
55.100
8,683
10,510
16.1
14.6
1.8
1.7
11.5
10.4
9.5
8.7
20.0
9.8
1.5
CoE
42.050
15,377
18,522
16.4
14.8
2.0
1.9
12.2
10.6
9.9
9.0
6.6
10.5
1.4
CoF
51.900
7,429
8,614
21.1
18.9
2.0
1.9
13.3
12.7
10.8
10.3
8.2
12.0
1.6
CoG
27.000
11,048
12,957
18.6
16.9
1.9
1.9
10.7
10.8
8.6
8.7
10.7
10.0
1.7
CoH
28.600
7,561
12,196
23.8
22.0
1.4
1.4
11.4
11.8
7.8
7.9
1.8
12.5
1.8
CoI
47.500
6,475
7,199
21.0
18.9
1.5
1.4
13.0
13.4
10.4
10.2
55.8
11.0
1.7
CoJ
23.250
7,149
9,416
19.3
17.0
2.0
2.0
20.3
12.9
14.4
10.1
4.0
11.8
1.4
CoK
43.750
20,435
24,639
16.3
14.4
1.2
1.2
14.3
13.2
10.5
9.7
8.8
13.8
1.0
Mean
18.5
16.7
1.7
1.7
13.0
12.1
10.1
9.5
12.8
11.7
1.4
Median
18.1
16.1
1.8
1.7
12.2
11.8
9.9
9.1
8.8
11.8
1.4
High
23.8
22.0
2.7
3.1
20.3
14.6
14.4
12.3
55.8
13.8
1.8
Low
16.0
14.4
0.7
0.7
10.7
10.4
7.8
7.9
1.8
9.8
1.0
25
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Project Training

Operating Statistics
Sales
EBIT
Net Income
EPS
LTM
$MM
Margin
%
LTM
$MM
Margin
%
LTM
$MM
Margin
%
LTM
$
CoA
8,057.0
2,123.0
26.3
1,799.0
22.3
1,076.0
13.4
2.33
CoB
23,754.3
1,762.9
7.4
1,327.6
5.6
631.0
2.7
1.41
CoC
8,372.0
1,388.0
16.6
1,133.0
13.5
523.0
6.2
4.06
CoD
5,923.5
1,106.5
18.7
910.5
15.4
528.3
8.9
3.27
CoE
9,180.0
1,864.7
20.3
1,524.2
16.6
830.9
9.1
2.14
CoF
4,397.8
798.0
18.1
647.4
14.7
342.8
7.8
2.30
CoG
6,784.1
1,501.2
22.1
1,215.0
17.9
715.1
10.5
1.40
CoH
8,791.0
1,568.0
17.8
1,068.0
12.1
422.0
4.8
1.58
CoI
4,892.5
692.1
14.1
552.4
11.3
273.3
5.6
1.97
CoK
19,838.0
2,346.0
11.8
1,728.0
8.7
726.8
3.7
1.45
Company
EBITDA
LTM
$MM
Mean
17.1
13.5
7.5
Median
17.8
13.5
7.8
26
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Project Training

Credit Statistics
Net
Debt/Adj.
Bk. Cap(1)
%
LTD/
Bk. Cap.(2)
%
LTD/
Mkt. Cap.
%
EBIT/
Interest
x
EBITDA/
Interest
x
Cash Flow
as % of
Total Debt
%
EBIT/
Total
Assets
%
Net Inc./
Book Value Credit
% Rating
CoA
68.8
46.0
6.4
10.5
12.3
42.9
25.7
72.5 AA/Aa3
CoB
60.5
47.8
17.8
4.7
6.2
21.6
10.7
23.6 BBB/Baa1
CoC
67.5
68.1
16.7
6.9
8.4
26.8
18.0
49.9 A+/A2
CoD
80.8
79.3
16.0
8.0
9.8
40.6
23.3
122.0 A+/A2
CoE
57.4
55.6
16.0
6.7
8.2
31.4
18.8
35.6 A+/A1
CoF
56.7
53.2
12.2
7.5
9.3
39.7
19.9
37.9 A+/A1
CoG
64.9
57.9
11.4
10.8
13.4
51.0
24.1
CoH
52.5
51.9
37.5
3.3
4.8
19.4
8.9
10.0 BBB/Baa2
CoI
86.2
88.2
11.8
7.7
9.6
42.8
21.4
235.4 BBB+/Baa1
CoK
62.7
56.9
11.3
10.8
14.7
24.5
15.5
36.2 AA-/A1
Mean
64.9
59.6
16.1
7.2
9.1
33.7
17.6
59.3
Median
62.7
55.6
16.0
7.5
9.3
31.4
18.8
37.0
Company
Notes
1. Net Debt = short term debt + long term debt + minority interest - cash and cash equivalents.
Adjusted book capitalization = total debt + preferred stock + book equity
2. Book capitalization = long term debt + minority interest + book equity
69.3 AA/Aa1
27
NYIBDF13\162526\A2\11 JUL 2001\6:53 AM\36
Project Training
Tips, Shortcuts and Pitfalls

Do
Do Not
Call CFD Coverage group to see if the

comps already exist
Forget to convert numbers reported in

foreign currencies to dollars
E-mail BIS to request research ASAP
Forget to calendarize inputs
Use Morgan Stanley standard definitions
Forget to NM (Not Meaningful) any

irrelevant statistics (e.g. negative
multiples)
Back out extraordinary items

Tax effect extraordinary items where
necessary
Footnote all adjustments
Overlook the effect of outliers on mean

and median multiples
Double check the numbers

Always include mean and median values
Use consistent formatting
28
NYIBDF13\162526\A2\11 JUL 2001\6:53 AM\37
Project Training

Summary
Comparable companies analysis is meaningful

It is firmly grounded in market-based valuation - it reflects what the market tells us
Regardless of whether or not the market is correct, it is an important benchmark
It provides a trading range and, after applying a control premium, an acquisition value
It is the most widely used valuation technique in the financial and business communities
for example, financial sponsors rely heavily on comparable companies valuation, both as a
benchmark and to formulate an idea of exit value
When analyzing comparable companies, a number of variables have to be included
Relative operating performance: companies with higher profitability should yield higher
valuations
Impact of capital structure: the degree of leverage impacts earnings levels, the risk of the
business and future growth prospects
Specific situations make normalizing earnings necessary
Highly cyclical industries
Large differences in leverage within set of comparable companies
Always read research analyst commentary on the company which is being valued or analyzed
Also read research analyst commentary on the set of comparable companies to explain trading
levels (e.g., differences in multiples for companies which appear fairly similar)
Comparable companies analysis is also essential for purposes of calculating or at least crosschecking the reasonableness of the Terminal Value derived from DCF valuation
29
NYIBDF13\162526\A2\11 JUL 2001\6:53 AM\38
Project Training
Comparable Companies Exercise

Selected Media Industry Companies (1)
Company
Share
(2)
Price
(US$)
Equity
Value
($MM)
Price/
Earnings
LTM
2001E
x
x
Agg.
Value
($MM)
Aggregate Value/
2002E
x
Revenue
LTM
2001E
x
x
2002E
x
LTM
x
EBITDA
2001E
x
2002E
x
Consumer Publishers
EMAP
$10.29
$2,594
$4,016
13.7x
11.9x
10.8x
2.7x
2.6x
N/A
13.8x
13.9x
N/A
Thomson
32.91
20,557
24,657
41.7x
35.0x
30.6x
3.9x
3.1x
2.8x
16.0x
12.7x
11.2x
McGraw-Hill
66.77
13,252
14,435
24.7x
22.2x
N/A
3.3x
3.0x
2.8x
14.5x
12.9x
11.9x
Scholastic
40.84
1,409
2,164
15.2x
17.1x
N/A
1.2x
1.1x
N/A
12.0x
9.3x
N/A
Houghton Mifflin
59.87
1,834
2,283
27.2x
23.3x
21.0x
2.3x
2.1x
N/A
15.8x
11.5x
N/A
John Wiley
22.60
1,418
1,551
24.8x
21.0x
17.7x
2.5x
2.3x
2.1x
13.8x
12.8x
N/A
Mean
24.6x
21.8x
20.0x
2.7x
2.4x
2.6x
14.3x
12.2x
11.6x
Median
24.8x
21.6x
19.3x
2.6x
2.4x
2.8x
14.2x
12.8x
11.6x
Cable
Cablevision Systems
$60.70
$11,416
$18,460
NM
NM
NM
5.0x
4.7x
4.3x
24.9x
19.8x
18.7x
Comcast Corporation
39.30
46,413
56,527
NM
NM
NM
6.5x
5.8x
5.1x
22.5x
20.0x
16.6x
Cox Communications
42.85
27,037
27,110
NM
NM
NM
7.6x
6.6x
5.8x
19.3x
17.2x
14.8x
Insight Communications
26.40
1,583
6,191
NM
NM
NM
10.0x
9.4x
8.4x
22.8x
19.0x
17.1x
Mean
NM
NM
NM
7.3x
6.6x
5.9x
22.4x
19.0x
16.8x
Median
NM
NM
NM
7.0x
6.2x
5.4x
22.6x
19.4x
16.9x
Streaming Data
Inktomi
$8.34
$1,115
$981
NM
NM
NM
5.0x
5.9x
4.4x
NM
NM
NM
Real Networks
11.35
2,043
1,594
NM
NM
NM
7.5x
7.5x
5.7x
NM
NM
NM
WebEx
20.77
855
816
NM
NM
NM
32.2x
10.6x
5.4x
NM
NM
45.1x
iBEAM
0.30
38
49
NM
NM
NM
1.8x
1.3x
0.6x
NM
NM
6.5x
Company X
$22.70
Mean
NM
NM
NM
11.6x
6.3x
4.0x
NM
NM
25.8x
Median
NM
NM
NM
6.2x
6.7x
4.9x
NM
NM
25.8x
$16,633
Notes
1. Financials as per March 31, 2001 10-Q
2. Share prices as of 7/9/01
30
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Project Training
Comparable Companies Exercise (contd)

Company X - Balance Sheet (000s)
As of
Mar. 31,
2001
ASSETS
Current Assets
Cash & Cash Equivalents
Marketable Securities
Accounts Receivable
Receivables from related party
Prepaid expenses and other current assets
Total current assets
$125,562
5,140
217,667
6,480
77,719
432,568
PP&E
Accumulated depreciation
PP&E, net
6,745,005
(1,244,119)
5,500,886
7,145,811
(1,878,292)
5,267,519
Other investments and deferred charges

Accumulated amortization
Deferred charges, net
18,950,985
(2,197,291)
16,753,694
18,947,631
(1,878,929)
17,068,702
Other assets
TOTAL ASSETS
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable and accrued expenses
Total current liabilities
Credit facilities
Notes outstanding
Other long-term debt
Deferred fees - related party
Other long-term liabilities
Minority interest
Redeemable securities
TOTAL LIABILITIES
TOTAL STOCKHOLDERS' EQUITY
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
$17,171
2,250
193,811
4,592
92,656
310,480
As of
Dec. 31,
2000
293,664
274,777
$22,858,724
$23,043,566
$1,169,766
1,169,766
$1,367,234
1,367,234
6,419,750
7,286,181
1,416
7,574,500
5,483,984
1,971
13,751
331,857
4,783,692
0
20,006,413
13,751
285,266
4,089,329
1,104,327
19,920,362
2,852,311
3,123,204
$22,858,724
$23,043,566
31
NYIBDF13\162526\A2\11 JUL 2001\6:53 AM\40
Project Training
Comparable Companies Exercise (contd)

Company X - Income Statement and Operating Projections (000s)
Three
Months Ended
Mar. 31, 2001
Revenues
Three
Months Ended
Mar. 31, 2000
$873,797
$3,249,222
$721,604
472,147
695,895
6,038
13,721
1,187,801
1,651,353
2,473,082
40,978
55,243
4,220,656
371,769
546,100
15,500
12,508
945,877
($314,004)
($971,434)
($224,273)
(310,832)
92
(59,917)
0
(370,657)
(1,059,130)
7,348
(19,262)
(12,467)
(1,083,511)
(230,914)
5,435
132
0
(225,347)
(684,661)
(2,054,945)
(449,620)
403,962
1,226,295
268,906
($280,699)
($828,650)
($180,714)
2001E
2002E
Revenue
$3,979.8
$4,790.0
EBITDA
1,823.2
2,152.9
Costs and Expenses

Operating, general and administrative
Depreciation and Amortization
Option compensation expense
Corporate expense charge
Operating Income (Loss)

Other income (expense)
Interest expense
Investment income
Income related to indexed debt
Equity in net losses (income) of affiliates
Operating income before tax and minority interest

Minority interest
Net income
Projections
(1)
($MM)
Year
Ended
Dec. 31, 2000
Notes
1. As per Morgan Stanley equity research
32
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Project Training
Tab B
NYIBDF13\162526\A2\11 JUL 2001\6:53 AM\42
Project Training
Precedent Transaction Analysis Overview

Uses
Valuing a business in a change of control situation

Provide statistics on particular transactions as basis for discussion
Display historic acquisition appetite of industry participants and determine willingness to pay full price
Determine the market demand for different types of assets (i.e., frequency of transactions and premiums paid)
Advantages
Disadvantages
Based on public information
Public data on past transactions can be limited and

misleading
Realistic in the sense that past transactions were

successfully completed at certain premiums. The
analysis therefore indicates a range of plausibility
for offered premiums
Precedent transactions are rarely directly

comparable
May show trends such as consolidation, foreign

acquirors, financial acquirors, etc.
Not all aspects of a transaction can be captured in

multiple valuation (e.g., commercial agreements,
governance issues)
Provides guidance to assess likely interlopers and

their willingness and ability to pay
Values obtained often vary over a wide range and

therefore can be of limited use
Market conditions at the time of a transaction can
have substantial influence on valuation (e.g.,
business cycle considerations, competitive
environment at the time of the transaction, scarcity
of the asset at the time of the transaction)
33
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Project Training

Unaffected Premium
Definition
Represents the premium of the offer price per share to the targets stock price before the
transaction was announced or rumored in the market. Usually this calculation is based on
the targets stock price four weeks prior to the announcement of the transaction
(unaffected price)
Issues
There often is more to a transaction than a simple sale of an asset/company
Commercial agreements
Governance issues (Board and management composition, headquarters)
Competitive environment at the time of the transaction
Scarcity of the relevant asset
It is necessary to include business cycle considerations in valuation
e.g., lower multiples are usually paid in peak industry years
34
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Project Training
Identification of Precedent Transactions

The quality of PPaids analysis is based on the selection of the most applicable precedent
transactions
Industry: target companys business and financial characteristics should be comparable
Size of the deal: transactions that are close in size to the target that is being evaluated are more
relevant
Private deals: it is often very difficult to obtain information on private deals; news articles
may be the only available source
Morgan Stanley has a wide variety of information sources that help in selecting the appropriate
list of transactions for a precedent transactions analysis
The M&A Database (email MAData@msdw.com or call Rich Butler 1-7852) can do searches
by:
SIC codes
Time frame
Type of deal (e.g., completed only, completed and pending, completed and pending and
terminated, U.S. only, U.S. and international)
Transaction value
The relevant Morgan Stanley Corporate Finance industry group
Merger Proxies of transactions in the relevant industry, which may list comparable transactions
Industry and trade publications
Research reports
35
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Ppaids Output
Overview
Premiums Paid usually appear in one or two-page format

In two-page format, the first page will focus on the business/assets acquired, consideration used
and the other terms of the transaction
The second, or only, page of the output will list the announcement date, acquiror/acquiree,
aggregate value and equity value of the deal, appropriate industry multiples and the premium to
the unaffected stock price
Multiples
Aggregate Value Paid

Output contains two categories pertaining to aggregate value paid. Equity column represents
only the equity paid. Aggregate Value represents Equity + Debt - Cash. Use Aggregate
Value for the exhibit. There may be a time lag between the date of the transaction and the
disclosure/listing of the Aggregate Value
Aggregate Value/ EBITDA
Aggregate Value/EBIT
Calculate LTM EBITDA and LTM EBIT using the financial statements from the time of the
Transaction
Aggregate Value / LTM Revenues
Calculate Equity Value as described above
Revenues listed on Premiums Paid output are usually on a LTM basis. Use appropriate annual
or 10-Q to verify. Note that there typically is a 25-30 day lag between the end of a fiscal
quarter and the announcement of quarterly revenues and earnings
36
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Ppaids Output (contd)

Equity Value / Book Value
Equity Value / Book Value of Total Cap ratio can be substituted for Price / Book Value of
Equity. Check with a team member to determine the appropriate ratio
Calculate Book Value of Total Cap by summing the Total Debt, Preferred, and Common
Equity accounts from the annual report or 10-Q that corresponds with the date of the
transaction. Note that there is a 45-day lag between the end of a fiscal quarter and the required
filing date, and a 90-day lag in the case of annual reports
NTM P/E
Divide the transaction price per share by the next twelve months (NTM) EPS - see Factset for
the NTM EPS at time of announcement
Price / Cash Flow
The Price / Cash Flow category is not always standard on the premiums paid exhibit. Check
with team members to ascertain whether or not inclusion of P/CF is appropriate
Take the stock price from the date of transaction
Take the LTM operating cash flow from the companys financial statements. Do not include
changes in working capital, other income or extraordinary items in this calculation. Divide
cash flow by the average number of shares outstanding for the period preceding the transaction
to calculate per share cash flow
Premium Paid Above Market
These values are usually listed for the month prior, day prior and day after the transaction
37
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Precedent Transactions
Date
Announced
Target/Acquiror
Target Business Description
Deal Highlights
11/12/98
Heritage Bathrooms PLC/Masco Corp
A U.K. manufacturer and distributor of

residential bathroom products
220p ($3.70) per share. Earn-outs

could rasie price to $76.8MM
2/17/98
Zurn Industries/U.S. Industries
A leading manufacturer of plumbing and

bath products
1.6 USI shares for each Zurn share.

Creating the no. 2 NA bath-plumbing
Co.
9/30/97
Creative Specialties Inc./Moen Inc.

(Fortune Brands Inc.)
A leading bathroom accessories

company, selling products primarily
under the CSI-Donner brand name
N/A
3/20/97
Falcon Building Products/Investcorp
A leading NA manufacturer and supplier

of highly engineered building products
serving residential, light commercial and
consumer markets
$17.75 per share LBO
3/4/97
Geberit International SA/Doughty

Hanson & Co.
Family owned Swiss company, Europes

leading manufacturer of sanitary ware
and plumbing systems
LBO
12/16/96
Eljer Industries Inc./Zurn Industries Inc.
A leading manufacturer and marketer of

building products
$24 per share Cash offer
8/28/85
Porcher/American Standard Companies
A French manufacturer an distributor of

plumbing products
7/23/90
Ceramica Dolomite SpA Blue Circle

Industries PLC
Italys leading manufacturer of ceramic

building products
Agg. Val/
Eq. Val.
$MM
LTM Multiples (x)
Current Forward Year Multiples (x)
Premium to
unaffected Price
%
67.6
67.6
Agg Val. / Sales

Agg Val. / EBITDA
Agg Val. / EBIT
Eq. Val. / N.I.
Eq. Val. / Book Val
1.8n 2.1
N/A
8.9 10.1
12.3 14.0
N/A
Agg Val. / Sales

Agg Val. / EBITDA
Agg Val. / EBIT
Eq. Val. / N.I.
N/A
N/A
N/A
10.7 12.1
41
765.0
555.0
Agg Val. / Sales

Agg Val. / EBITDA
Agg Val. / EBIT
Eq. Val. / N.I.
Eq. Val. / Book Val
1.3
9.5
12.1
16.8
2.2
Agg Val. / Sales

Agg Val. / EBITDA
Agg Val. / EBIT
Eq. Val. / N.I.
1.2
8.0
10.1
17.0
38
30.0
Agg Val. / Sales

Agg Val. / EBITDA
Agg Val. / EBIT
Eq. Val. / N.I.
Eq. Val. / Book Val
0.6
N/A
N/A
N/A
N/A
Agg Val. / Sales

Agg Val. / EBITDA
Agg Val. / EBIT
Eq. Val. / N.I.
N/A
N/A
N/A
N/A
N/A
590.0
365.0
Agg Val. / Sales

Agg Val. / EBITDA
Agg Val. / EBIT
Eq. Val. / N.I.
Eq. Val. / Book Val
0.9
7.7
9.7
11.9
10.7
Agg Val. / Sales

Agg Val. / EBITDA
Agg Val. / EBIT
Eq. Val. / N.I.
1.0
7.7
9.3
12.5
1,210.5
Agg Val. / Sales

Agg Val. / EBITDA
Agg Val. / EBIT
Eq. Val. / N.I.
Eq. Val. / Book Val
2.0
N/A
12.9
N/A
N/A
Agg Val. / Sales

Agg Val. / EBITDA
Agg Val. / EBIT
Eq. Val. / N.I.
N/A
N/A
N/A
N/A
N/A
254.3
172.9
Agg Val. / Sales

Agg Val. / EBITDA
Agg Val. / EBIT
Eq. Val. / N.I.
Eq. Val. / Book Val
0.6
6.8
9.0
13.5
N/M
Agg Val. / Sales

Agg Val. / EBITDA
Agg Val. / EBIT
Eq. Val. / N.I.
0.6
N/A
N/A
N/A
88
$25MM for 67% stake ASD does not

already own, plus assume $35.7MM
debt
73.0
Agg Val. / Sales

Agg Val. / EBITDA
Agg Val. / EBIT
Eq. Val. / N.I.
Eq. Val. / Book Val
0.3
N/A
N/A
N/A
N/A
Agg Val. / Sales

Agg Val. / EBITDA
Agg Val. / EBIT
Eq. Val. / N.I.
N/A
N/A
N/A
N/A
N/A
N/A
66.3
Agg Val. / Sales

Agg Val. / EBITDA
Agg Val. / EBIT
Eq. Val. / N.I.
Eq. Val. / Book Val
0.9
N/A
6.6
12.8
N/A
Agg Val. / Sales

Agg Val. / EBITDA
Agg Val. / EBIT
Eq. Val. / N.I.
N/A
N/A
N/A
N/A
N/A
38
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Precedent Transaction Worksheet

Analyst Exercise
Target Acquisition Value
Key Facts
Name
Industry
Country
Advisor
Target
Time Warner
Media
USA
Morgan/WP
Target Offer Price Per Share
Acquiror
AOL
Technology
USA
SSB/ML/GS
Fully diluted shares outstanding (MM)
Announcement Date
1/10/00
Equity Value
Status
(Closed/Pending)
Closed
Option Proceeds (-)
Target Offer Price Per Share
Short-Term Debt (+)
26.0
Long-Term Debt (+)
17,812.0
Minority Interest (-)
3,175.0
Cash & Cash Equivalents (-)
Acquiror Price Per Share (One Day Prior)
645.0
Aggregate Value ($MM)
Exchange Ratio
Target Historic Data (LTM)
Premium Data
$MM
($)
$27,333
EBITDA
8,564
EBIT
6,035
Net Income
1,896
2,982.0
Total Equity Value ($MM)
Exchange Ratio
Sales
1,434,585
Target Share Price 1 day

before Announcement
Transaction Multiples
$64.75
Target Share Price 30 days

before announcement
65.13
Target Share Price 1 day

after announcement
86.13
Target Share Price 30 Day

after announcement
85.19
Acquiror share price 1 day

before announcement
73.00
Acquiror share price 1 day

after announcement
64.00
Acquiror share price 30 days

after announcement
58.50
Agg. Value/LTM Sales
Agg. Value/LTM EBITDA
Agg. Value/LTM EBIT
Equity Value/LTM Earnings
Premium to Unaffected Share Price

(Consideration/Share Price
30 days before announcement)
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AOL / Time Warner Press Release

America Online and Time Warner Will Merge to Create World's First
Internet-Age Media and Communications Company
AOL Time Warner Will Be Premier Global Company
Delivering Branded Information, Entertainment and
Communications Across Rapidly Converging Media
Platforms and Changing Technology
DULLES, VIRGINIA and NEW YORK, NEW YORK, January 10, 2000 -America
Online, Inc. [NYSE:AOL] and Time Warner Inc. [NYSE:TWX] today
announced a strategic merger of equals to create the world's first fully
integrated media and communications company for the Internet Century in
an all-stock combination valued at $350 billion.
Under the terms of a definitive merger agreement approved by unanimous
votes at meetings of each company's board of directors, Time Warner and
America Online stock will be converted to AOL Time Warner stock at fixed
exchange ratios. The Time Warner shareholders will receive 1.5 shares of
AOL Time Warner for each share of Time Warner stock they own. America
Online shareholders will receive one share of AOL Time Warner stock for
each share of America Online stock they own.
40
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Section 4
Intrinsic Valuation
NYIBDF13\162526\A2\11 JUL 2001\6:53 AM\52
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Tab C
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Intrinsic Valuation
Discounted Cash Flow Analysis Overview

Uses
Intrinsic Valuation of the business as a going concern

What a potential buyer should pay for a business
The DCF is used as an additional point of reference when valuing a company because it
provides a theoretical benchmark, independent of market biases or control premia
Advantages
Disadvantages
Theoretically, the most sound valuation method
Valuation is highly sensitive to underlying

assumptions for cash flows (i.e., validity of
projections), terminal value calculation and
discount rate
Forward looking analysis, based on cash flow (less

affected by accounting rules than net income);
incorporates expected operating strategy into the
model
Less influenced by volatile public market
conditions
Allows a valuation of the separate components of a
business or synergies separately from the business
Terminal value often represents significant portion

of total value
Impervious to market dynamics and associated
control premia, theoretical valuation may
misrepresent what would actually be paid for a
business
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Intrinsic Valuation
Introduction to DCF Analysis

DCF value is simply the present value of the projected cash flows of a business
Cash flows are discounted to reflect the time value of money and the riskiness of the asset
DCF analysis yields the value of the assets of a business, regardless of how it is capitalized
Capitalization impacts value only through weighted average cost of capital (WACC)
Unlevered Free Cash Flow is the cash generated
By all of the assets employed in the business
Without regard to capital structure and financing (thus unlevered)
Available to all providers of capital
Differentiate between definitions of
Cash flow from operations
Cash flow available for debt service (levered free cash flow)
Unlevered free cash flow
Key steps
Identify key value drivers
Use the management case as the basic outline
Develop sensitivity scenarios
Determine the methodology for the Terminal Value calculation (i.e., perpetual growth rate,
asset/equity multiple)
Calculate the WACC to discount cash flows
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Intrinsic Valuation
Calculating Unlevered Free Cash Flows

Definition
Unlevered Free Cash Flow is Defined as

Net Income
Depreciation
Amortization
Change in Deferred Taxes
Other Non-Cash Charges
After-Tax Interest Expense
Investment in Working Capital
Cash Flow Adjustments
Depreciation, amortization, change in deferred taxes and other non-cash charges are added back to Net Income
Assumes that these items were already deducted from Net Income
These items are added back at 100% of the amount and not tax adjusted because no cash was spent on these
items
Interest expense is added back net of tax effect
As interest expense is deductible for tax purposes, lower taxes are paid as a result of interest expense
Therefore, only the after-tax effect of interest has to be added back
Capital Expenditures and other uses of cash
Outflows of cash required to run the business that are not reflected by the income statement
Investment in working capital
Investment in inventories is typically required as sales increase
As sales increase, more sales will be made on trade (accounts receivable); the implication is that not all sales on
the income statement, which flow through to net income, are cash and an adjustment has to be made
Working Capital: the difference between non-cash current assets and current liabilities, excluding short-term
debt
Only make adjustment to cash flow for the incremental changes in working capital accounts
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Intrinsic Valuation
Discounting Unlevered Free Cash Flows (contd)

At what point during the year do the cash flows occur?
In reality, cash flows occur throughout the year level vs. seasonal
Assuming that all cash flows occur at the end of the year, as many practitioners do, is therefore
inaccurate
Morgan Stanley assumes cash flows occur in the middle of the period, e.g.,
December 31 fiscal year end: UFCFs are assumed to occur on June 30
August 31 fiscal year end: UFCFs are assumed to occur on February 28
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Intrinsic Valuation
Mid-Period Convention
Cash Flow #1 Valuation Date 6/30/01
CF1
12/31/00
6/30/01
12/31/01
We only receive 6/12 of CF1
12/31/00
12/31/00
6/30/01
12/31/01
Valuation Date
We assume that the cash flow

occurs in the middle of the
period
6/30/01
9/30/01
12/31/01
...therefore we discount back
only 3/12 of a year to obtain the
present value
12/31/00
6/30/01
Present Value of
Cash Flow #1
9/30/01
12/31/01
(CF1*6/12)
(1+r)3/12
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Intrinsic Valuation
Mid-Period Convention (contd)
PV1 =
(CF1*6/12)
(1+r)3/12
Again, we assume the cash flow

occurs in the middle of the
period
CF1
12/31/00
12/31/
6/30/01
12/31/01
9/30/01
3/12
PVTOTAL = PV1 + PV2 + PV3 + PV4

PV2 =
CF2
(1+r)1
CF2
12/31/00
6/30/01
Valuation Date
12/31/01
6/30/02
12/31/02
1
PV3 =
CF3
(1+r)2
CF3
12/31/00
6/30/01
12/31/01
6/30/02
12/31/02
6/30/03
12/31/03
2
PV4 =
CF4
(1+r)3
CF4
12/31/00
6/30/01
12/31/01
6/30/02
12/31/02
6/30/03
12/31/03
6/30/04
12/31/04
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Intrinsic Valuation
Mid-Period Convention (contd)

Cash flows CF2 to CF4 are
discounted back to 6/30/01;
therefore, we have to
discount the sum of
PV2 + PV3 + PV4 by one half
year to solve for the present
value at 12/31/00
PV1 =
CF1
(1+r)6/12
CF1
12/31/00
6/30/01
12/31/01
6/12
PV2 =
PVTOTAL = PV1 +
CF2
PV2 + PV3 + PV4

(1+r)6/12
(1+r)1
CF2
12/31/00
6/30/01
12/31/01
6/30/02
12/31/02
1
Valuation Date
PV3 =
CF3
(1+r)2
CF3
12/31/00
6/30/01
12/31/01
6/30/02
12/31/02
6/30/03
12/31/03
2
PV4 =
CF4
(1+r)3
CF4
12/31/00
6/30/01
12/31/01
1
6/30/02
12/31/02
2
6/30/03
12/31/03
6/30/04
12/31/04
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Intrinsic Valuation
Terminal Value
When we perform a DCF analysis, we project cash flows for N years and then estimate a
terminal value for the ongoing value of the business beyond year N. (Alternatively, the
terminal value can be viewed as the sale price of the business in year N)
There are two basic methodologies employed at Morgan Stanley to calculate a terminal value:
(1) apply a multiple to a specified financial statistic (EBITDA, EBIT, Net Income) in the
terminal year, or
(2) assume a growing perpetuity based on the terminal years cash flow. Both of these
methodologies are discussed on the following pages
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Intrinsic Valuation
Terminal Value (contd)

Multiple Method
Assumes the business is sold at the end of the projection period
Use the most appropriate multiple or range of multiples for the Companys industry (overlap
with comps methodology)
Be careful when applying LTM vs. forward multiples
The multiple method assumes terminal value occurs at the end of the final period (as compared
to the cash flows, which are assumed to occur at mid-year)
Asset multiples: sales, EBITDA, or EBIT
Equity multiples: net income
Unlevered free cash flows yield Asset Values, so if you use an equity multiple, you must
convert the result to an asset value by adding net debt in the last year to the equity value
Relevering: as the Company has paid down debt over the forecast period, a multiple
valuation based on net income may have to be based on an adjusted net income
Perpetual Growth Method
Assumes unlevered FCFs continue in perpetuity, growing at some constant rate
Choosing growth rate for perpetuity requires careful thought
Always cross-reference with multiple method
Note that if the implied P/E multiple is out of line, this is probably due primarily to the capital
structure of the Company in the terminal year
Normalize terminal year earnings
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Intrinsic Valuation
Terminal Value
Multiple Method
EBITDA and EBIT are both aggregate value multiples used to calculate the terminal value
Example
12/31/00
The unlevered free cash flows are assumed to come in the middle of the
period...
12/31/01
12/31/02
12/31/03
12/31/04
but the EBITDA/EBIT statistics are period-end
Valuation Date
Steps
1) Based on the number of periods of cash flow (e.g., 5 periods vs. 10 periods) select the
EBITDA or EBIT statistic of the final period
2) Analyze the comps and p-paids to select a reasonable range of multiples
3) Multiply the EBITDA/EBIT statistic times the multiple
4) Discount the final period terminal value back to the valuation date
12/31/00
12/31/01
12/31/02
12/31/04
12/31/03
Valuation Date
EBITDA
* Multiple = Terminal Value in Final Period
or
EBIT
Discount Terminal Value in final period back

to the valuation date
12/31/00
12/31/01
12/31/02
12/31/03
12/31/04
TV =
T.V. Final Period

(1+r)4
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Intrinsic Valuation
Terminal Value
Perpetual Growth Rate Method
The perpetual growth rate represents the growth rate of the unleveled free cash flows into perpetuity (the PGR
assumes that the entity will continue to be a going concern)
Example
The unlevered free cash flows are assumed to occur
in the middle of the period
12/31/00
12/31/01
12/31/02
12/31/04
Steps
1) Based on the number of periods of cash flow (e.g., 5 periods vs. 10 periods)
select the unlevered free cash flow statistic of the final period
2) Analyze the comps to select a reasonable range of growth rates and/or ask
your deal team for guidance
3) Solve for the terminal value at the valuation date
Valuation Date
12/31/00
12/31/03
12/31/01
12/31/02
12/31/03
12/31/04
TV Final Period =
Unlevered FCF *(1+g)

(r-g)
Because the cash flow occurs in the

middle of the period we only need to
discount back 3 periods
Valuation Date
Discount the Terminal Value in the final period back

to the valuation date
TV =
TV Final Period
(1+r)3
12/31/99
12/31/00
12/31/01
12/31/02
12/31/03
12/31/04
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Intrinsic Valuation
Implied Terminal Value Multiples

Perpetual Growth Rate Method
Aggregate Value Multiples
Sales
EBITDA
EBIT
TV Final Period * (1 + r)6/12
Multiple =
EBITDA, EBIT or Sales of Final Period
The PGR terminal value is calculated off the mid-period unlevered

free cash flow statistic...
12/31/00
12/31/01
12/31/02
12/31/03
12/31/04
the Sales, EBITDA, or EBIT statistic is

period end...
hence, we have to bring the terminal value forward

one half period. (End Period Terminal Value and
End Period Sales,EBITDA, or EBIT = Apples to Apples)
Equity Value Multiples
Net Income
Make sure to bring to the PGR TV forward to

period end
TV Final Period * (1 + r)6/12 - Net Debt of Final Period

Multiple =
Net Income of Final Period
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Intrinsic Valuation
Comparison of Terminal Value Methodologies

Multiple Method
Perpetual Growth Method
Assumes business/assets are sold at the end of the

projection period at current multiple valuation
levels
Assumes going concern

Be sure to cross reference with implied exit
multiples
When choosing an exit multiple consider

Current level of valuation (bullish, bearish)
Apply normalized multiple to normalized
earnings
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Intrinsic Valuation
Normalizing Earnings
DCF valuation in general is very sensitive to the calculation of terminal value; it is therefore
important to make sure that the assumptions underlying the terminal value are reasonable
Normalizing operating assumptions
The sales and operating margin assumptions for the final year should reflect an average year
(not bottom or top of the business cycle)
Depreciation and capital expenditures should be within the same range (steady state)
Normalizing financial structure
Assumptions for debt paydown and use of cash generated over the projection period affect the
capital structure of the company over time
When applying multiples for value calculations, earnings may have to be adjusted to reflect
optimal or typical capital structure
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Intrinsic Valuation
Weighted Average Cost of Capital

Concept
Cost of Equity
Capital Asset Pricing Model defines the cost of equity of a particular company as
Cost of Equity = Risk Free Rate + Beta x Market Risk Premium
10-year U.S. Treasury is used

as an approximation of risk free
investment return
Represents the financial and

systemic business risk of the
particular company vs. the
overall market portfolio (e.g.,
1 = risk equivalent to market
portfolio)
Expected long-term premium of

the overall market portfolio over
a risk free investment (currently
defined at 4%)
The Beta of any particular company reflects (i) the systemic business risk of the company; and (ii) the financial
risk (risk due to leverage of the company)
Individual company betas are estimated by several public sources (Barra, etc.)
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Intrinsic Valuation
Weighted Average Cost of Capital (contd)

Concept
Calculating the Cost of Equity for a Particular Company
Starts with the Predicted Equity Beta of comparable companies
These Betas reflect the systemic business and financial risk of the various companies. In order to adjust for
leverage, Betas of the comparable companies have to be unlevered
Levered Beta
Unlevered Beta =
1 + (D/E)(1-t) + (Pref./E)
The mean/median of the unlevered Betas of the comparable companies serves as an approximation of the
systemic business risk of the company being valued. To reflect the financial risk we relever the Beta with the
desired financial structure (usually a range)
Using the Capital Asset Pricing Model we can now calculate the cost of equity of the target company
(Rf = risk free rate, Rp = risk premium)
Cost of Equity = Rf+(Levered Beta) * Rp
With simple weighting we can now calculate the Weighted Average Cost of Capital for the target company
(V = total capitalization)
WACC = Cost of Equity x (E/V) + Cost of Debt x (D/V)(1-t) + Cost of Preferred (Pref./V)
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Intrinsic Valuation
Weighted Average Cost of Capital

As the beta reflects business risk it differs between industries. In general, one can differentiate
between defensive and cyclical industries
Defensive industries are on average less volatile than the market and therefore have a beta
between 0 and 1 (e.g., consumer goods)
Cyclical industries are on average more volatile than the market and therefore have a beta
greater than 1 (e.g., high tech., biochemical)
Within an industry group betas of specific companies vary due to numerous factors such as
Business mix (product, geography)
Financial leverage
Development stage (start up vs. long-term industry participant)
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Intrinsic Valuation

Summary
The DCF analysis is based on the future performance of a business. It is therefore highly
dependent on assumptions for
The underlying business model
The valuation benchmark and the financial statistics underlying the terminal value calculation
The discount rate
The underlying business model should be based on management estimates. Cross references to
historical operating performance as well as to peer group operating performance are necessary
(reality check)
Different terminal value calculation methodologies should be used as a reality check
Discount rate should be based on the WACC. Make sure that the target capital structure makes
sense within an industry context and the cost of debt reflects the level of leverage
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Intrinsic Valuation
Top Nine Pitfalls of DCF Analysis
1.
Expecting the Morgan Stanley model to be correct
2.
After-tax interest addback
3.
Discounting conventions calculated incorrectly
4.
Working capital changes
5.
First-year cash flow not adjusted
6.
Terminal value discounting adjusted for mid-period convention
7.
Perpetual growth vs. terminal multiple
8.
Debt/Equity in the WACC
9.
Cost of Debt in WACC calculation
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Intrinsic Valuation
Pencil and Paper Exercise Part I

Weighted Average Cost of Capital (WACC)
Company X
Comp A
Comp B
Comp C
.75
1.35
.87
900
800
950
400
100
100
2,200
2,400
475
700
9%
7%
10%
8%
Predicted Equity Beta

Debt
Preferred
Equity
Cost of Debt
Tax Rate = 40%
Risk Free Rate = 5.3%
Unlevered Beta
Cost of Equity for Company X
WACC for Company X
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Intrinsic Valuation
Pencil and Paper Exercise Part II

Information Company X
($MM)
12/31/00
12/31/01
12/31/02
12/31/03
1,400
1,500
1,550
1,600
110
120
130
140
Depreciation & Amortization
50
50
50
50
Change in Deferred Tax
20
20
20
20
Change in Other non-cash items
10
10
10
10
Change in non-cash Current Assets
37
37
37
37
Change in Current Liabilities

(excluding Short-term Debt)
30
30
30
30
70
60
65
50
Net Income
P/T Interest Expense (Tax Rate = 40%)

Valuation Information
Valuation Date:
September 30, 2001
Terminal Value Method:
Perpetual Growth Rate (assume 4%)
Discount Rate (WACC):
Calculated in Part I
Answers
PV of Cf1 =
PV of Terminal Value
PV of Cf2-5 =
PVTotal
% of PVTotal in
Terminus
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Section 5
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Tab D
Summary
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Merger Analysis
Summary
The merger analysis focuses on

Exchange ratio and pro forma ownership percentages for merger parties (in transactions with
stock consideration)
Pro forma financial impact to merged parties (earnings accretion/dilution, credit implications)
Value accretion/dilution
The exchange ratio and, therefore, pro forma ownership determine the split of the pie
Earnings accretion/dilution and multiple expansion/contraction determine the size of the pie
The analysis incorporates both the impact of the transaction to pro forma earnings and potential
capital markets reactions in terms of re-assessing P/E multiple (expansion/contraction)
The merger analysis can be based on static and/or dynamic models, which require different
levels of detail
For the purpose of Morgan Stanley Training we will focus on static merger models, i.e., mini
merger models. Note: A dynamic model is not always necessary to provide meaningful
insights
Goals of a successful merger
Maximize pro forma EPS and growth
Maximize credit rating (not specifically accounting related)
Maximize financial performance ratios
Impact of accounting treatment
Can play a significant role in transaction
Post-merger earnings can affect stock price
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Overview of Merger Analysis

Accretion/Dilution Analysis
Compares % contribution
of operating and market
value statistics from
transaction partners to
pro forma combined
entity
Compares the pro forma

financial impact of
transaction on transaction
partners (e.g., earnings
per share accretion/
dilution, pro forma credit
implications)
Analyzes potential share

price implications for
existing shareholders
Historical
Projected
Static analysis (mini

merger model)
Dynamic analysis
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Tab E
Accounting Issues
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New Accounting Rules

In 2001 the Financial Accounting Standards Board (FASB) instituted a change in the way
that mergers are accounted for
Prior to the decision, two accounting systems existed for merger transactions
Under pooling accounting, all assets were valued at their historic book value
Under purchase accounting, the acquirer was required to recognize the full value of the
target and record a goodwill asset of the value of the purchase price over the fair value of
the target. This goodwill was amortized over a period of years and decreased the targets
net income by the amortization amount
Pooling accounting has been eliminated and the purchase accounting system has been
substantially modified
The new method of accounting for mergers is discussed in the following pages
It is still unclear how these accounting changes will ultimately impact the market
Though the FASB has issued an initial ruling, they have yet to provide clarification on
many specifics of the new system
There will be a multitude of effects on M&A activity, corporate earnings and valuation,
financial statement presentation and specific industries
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Core Principles
Business Combinations Statement Key Points
Purchase accounting is required for all business combinations initiated after

June 30, 2001, thereby eliminating the use of the pooling-of-interests
method
The purchase price is allocated first to net tangible assets (i.e., acquired
assets and assumed liabilities) and then to identifiable intangible assets. Any
residual is attributed to goodwill
An identifiable intangible asset must be recognized separately from
goodwill
Identifiable intangible asset is an asset which meets one of the following
criteria:
The asset arises from contractual or other legal rights (e.g., trademarks, royalties,
construction permits or franchise agreements) or
The asset is separable from the acquired company and can be sold, licensed, rented,
exchanged or pledged (e.g., customer lists, databases or unpatented technology)
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Core Principles (contd)

Goodwill and Intangible Assets Statement Key Points
Goodwill will no longer be amortized and will be tested for impairment at least annually
Goodwill will be allocated across reporting units which will be the same level as (or one level
below) an operating segment
Goodwill impairment will take place if the fair value of the reporting unit is less than its book
value including goodwill
An impairment loss is measured as the excess of recorded goodwill over its implied fair value.
The implied fair value of goodwill should be calculated in the same manner that goodwill is
calculated when a business is acquired
Some amount of goodwill should be allocated to a significant amount of a reporting unit that is
sold or disposed of. This goodwill should be included in the gain/loss recognition of the
disposed reporting unit
Other intangible assets should be amortized over their useful life and reviewed for impairment
in a similar way to tangible assets
An intangible asset (other than goodwill) with an indefinite life (i.e., life that exceeds beyond
the foreseeable horizon) should not be amortized until its life is determined to be finite
A benchmark assessment should be completed before the annual impairment review. The
benchmark assessment will document and identify the net assets and the goodwill associated
with the reporting unit as well as the model and the key assumptions used to measure the fair
value of the reporting unit
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Financial Statement Presentation and Disclosure
The aggregate amount of goodwill as well as other intangible assets must be

presented as separate line items on the balance sheet
Goodwill impairment loss must be presented as a separate line item in the
operating section of the income statement. The portion of goodwill associated
with net assets to be disposed of must be recognized as part of the gain or loss
on disposal, not as an impairment loss
Amortization expense and impairment losses for intangible assets other than
goodwill should be presented in the operating section of the income statement
For a significant business combination the acquiring company has to disclose
information about the transaction including the reasons for the acquisition,
purchase price allocation to assets and liabilities, identifiable intangible assets,
and goodwill
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Transition and Effective Date
As a result of this transitional

period, over the next 12
months companies may not
be reporting financials that
are comparable on an
apples-to-apples basis
In any analysis it will be
necessary to diligence each
companys financial
reporting and ensure that
EPS estimates are
comparable
If companies are reporting
EPS under the old
accounting provision, their
numbers will have to be
adjusted for the new
amortization of intangibles
New goodwill and identifiable intangible assets with indefinite life, which are acquired in
transactions completed after June 30, 2001, will not be amortized.
For existing goodwill and identifiable intangible assets the nonamortization and impairment
rules will apply for fiscal years beginning after December 15, 2001
However, early adoption of the Statement will be permitted for companies with a fiscal year
beginning after March 15, 2001, for which first quarter financial statements have not been
issued
Companies with different fiscal year ends when can they stop amortizing goodwill?
31-Mar
Q1 2001 if the financials for Q1 are not issued before the new standard is in force
30-Jun
Q1 statements ending Sept 30, 2001 or Sept 30, 2002
31-Dec
Q1 2002 ending March 31, 2002
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Transition and Effective Date
No retroactive adjustment is allowed but pro forma information excluding amortization

will be provided
Accordingly, most companies will now have to wait until Q1 2002 to eliminate
amortization of existing goodwill, while all new goodwill will no longer need to be
amortized
The useful economic life of previously recognized intangible assets should be reassessed
upon adoption of the Statement, and remaining amortization periods should be adjusted
accordingly
Intangible assets deemed to have an indefinite life will not be amortized any longer
A benchmark assessment should be completed within six months of the date of adopting
the Statement for each reporting unit that includes goodwill (referred to as a transitional
benchmark assessment)
Any impairment loss due to the adoption of the Standard will be reflected as a change in
accounting principle and will be attributed to the first quarter regardless of when the
impairment is calculated during the year. Subsequent impairments should be reported as
operating losses
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Tab F
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Compares % contribution of
operating and market value
statistics from transaction
partners to pro forma
combined entity
Asset Value (Unlevered) Parameters
Equity Value (Levered) Parameters
Sales
Net Income
Gross Margin
Equity Value
EBITDA
EBIT
Aggregate Value
Example
Company A
$
Contribution
%
Contribution
%
Sales
6,298
56
5,000
44
EBITDA
1,216
60
800
40
EBIT
1,024
63
600
37
569
62
350
38
Net Income
Company B
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Tab G
Mini-Merger Analysis
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The Mini-Merger Model

Objectives
Understand the purpose of a basic mini-merger model and how it is used

Understand the mechanics behind the mini-merger
Calendarization of earnings estimates
Determining purchase price form of consideration (Cash vs Stock)
Income statement adjustments
Accretion/dilution
Breakeven synergies analysis
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Overview
The mini-merger model is a useful tool to use when trying to complete a back of the envelope
merger analysis for a potential acquisition
The mini-merger model is used to calculate earnings per share (EPS) accretion/dilution
What is earnings accretion/dilution?
The percentage change in a companys EPS as a result of a merger/acquisition/divestiture
compared to its standalone EPS
Why do we do it?
Provides an estimate of positive or negative change in stock price for those companies valued
on a multiple of EPS
Helps predict whether existing shareholders will favor or oppose proposed transaction
Basic methodology
Determine standalone EPS/Net Income for target and acquiror on same basis, using public data
sources (IBES, First Call, Equity Research)
Determine purchase price, form of consideration (i.e., mix of cash and stock)
Calculate income statement adjustments
amortization of intangibles
tax-affected interest expense
change in common dividend
shares issued
possible goodwill impairment
after tax synergies
Calculate pro forma EPS and compare to standalone EPS
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The Mini-Merger Model (contd)

Step 1: Determine Standalone EPS/Net Income on Same Basis
Form of EPS: basic and

diluted
Source of Earnings
Estimates
Public Companies (IBES,
First Call, Morgan Stanley
Research)
Median Earnings
Estimates
Acquiror
Fiscal Year Ending September 30,
EPS Diluted ($)
2000A
2001E
2002E
2003E
3.59
4.15
4.75
5.37
16
14
13
% Growth
Avg. Diluted Shares Out. (MM)
63.0
63.0
63.0
63.0
Net Income ($)
226
262
299
338
16
14
13
% Growth
Long-Term Growth Rate

Private Companies/
Divisions of Companies
Management/MSDW
estimates
Over the next 12 months
analysts should take
particular care when using
EPS estimates, because
companies will be
transitioning to the new
accounting standard at
different times
Different companies EPS
estimates may not be
comparable without
additional adjustments
for amortization of
intangibles
Target
Fiscal Year Ending December 31,
EPS Diluted ($)
2000A
2001E
2002E
2003E
1.35
1.73
2.13
2.60
28
23
22
16.0
16.0
16.0
16.0
22
28
34
42
28
23
22
% Growth
Avg. Diluted Shares Out. (MM)
Net Income ($)
% Growth
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Mini-Merger Model
Step 1: Determine Standalone EPS/Net Income on Same Basis
Acquiror has a Sept. 30th Fiscal Year End (FYE). Target has a Dec. 31st FYE
Restate Targets Net Income to Acquirors fiscal year end
Acquiror
FY00 = $262
FY01 = $299
3 mo.
9 mo.
FY99 = $22
FY00 = $28
Restated FY00 =
3 Mo. FY99 + 9 Mo. FY00 = $26
FY02 = $338
M A M
3 mo.
9 mo.
FY01 = $34
Restated FY01 =
3 Mo. FY00 + 9 Mo. FY01 = $32
3 mo.
M J
A S
9 mo.
FY02 = $42
Restated FY02 =
3 Mo. FY01 + 9 Mo. FY02 = $40
Target
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Step 2: Determine Purchase Price, Form of Consideration & Accounting Treatment
Acquiror purchases Target by paying a 25% premium to targets current stock price ($20.00)
Price Paid Per Share
= Target current stock price * (1 + Premium)

= $20.00 * (1 + 0.25)
= $25.00
Total Consideration Offered
= Price Paid Per Share * Total Target Shares Outstanding

(diluted)
= $25.00 * 16.0MM Fully-Diluted Shares Outstanding
= $400MM
Acquiror finances the purchase of Targets equity with 50% stock and 50% cash
Sources
%
Debt/Cash
200
50
Stock
200
50
$400
100
Total
Uses
$MM
Stock
$MM
400
100
$400
100
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Step 3A: Income Statement Adjustments Goodwill & Intangibles
The amount that a purchaser pays over the book value of the target must be allocated between
goodwill, identifiable intangibles, and asset step-up
This excess purchase price can be calculated as follows:
Purchase Price - Book Value = Excess Purchase Price
$400MM - $200MM = $200MM
Ultimately the amount of intangibles and goodwill will be determined by accountants.
However, in performing a mini-merger we can make the simplifying assumption that the
Excess Purchase Price is split evenly between identifiable intangibles and goodwill (with no
step-up in asset value)
50% * Excess Purchase Price = Goodwill
.5 * $200 = $100MM
50% * Excess Purchase Price = Identifiable Intangibles
.5 * $200 = $100MM
These intangibles are amortized over a determined period of time (this time period depends
upon the average useful life of the intangibles) to calculate the annual amortization
$100MM / 20 = $5MM
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Step 3B: Income Statement Adjustments Interest(1)
If the acquiror uses debt to finance purchase, the tax-affected interest expense on the debt is
deducted from earnings
Interest expense is tax-deductible
Therefore, as interest paid increases, income and taxes are lower
The tax-affected interest expense takes into account this tax shielding effect of interest
Tax-affect by multiplying interest expense by (1 - tax rate)
Calculation of Interest Expense (After-tax)
Assume interest rate of 8% and tax rate of 40%
After tax interest expense = debt raised * interest expense * (1 - tax rate)
$200MM * 8% * (140%) = $10MM/Year
Note
1. Only need to consider new debt. Existing debt interest expense is already incorporated in Street EPS estimates
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Step 3C: Income Statement Adjustments Pro Forma Shares Outstanding
If the acquiror uses equity to fund the transaction, the denominator of the EPS calculation must
include the new shares outstanding
Calculate the new shares issued by the acquiror by dividing the amount of equity consideration
used in the transaction by the acquirors share price
Acquiror price per share = $85/share
Total Equity Consideration = $200MM
Share Issued
= Equity Consideration/Acquiror price per share

= $200MM/$85
= 2.4MM Shares
Pro forma Shares = Existing Shares + New Shares (63.0MM + 2.4MM = 65.4MM
Shares)
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Example Summary Calculation
Results
EPS
Calculation
299
299
32
25.00
400
=
=
200 debt
200 stock
Equity Purchase Price-Target Book Value

400 - 200 = 200
50% * Excess Purchase Price
.5 * 200 = 100
50% * Excess Purchase Price
.5 * 200 = 100
Identifiable Intangible Assets / Amortization Period
100 / 20
(5)
Debt * Interest rate * (1-tax rate)

200 * 8% * (1 - .40)
(10)
-10 Interest Expense

316 Adjusted Income
65.4
65.4 Pro Forma Shares
=
=
4.83
4.83 Pro Forma EPS

4.75 Standalone EPS
1.68%
Step
Calculation
Acquiror Net Income
Earnings per share * fully diluted shares outstanding

4.75 * 63.0
Fiscal year adjusted earnings per share * fully diluted shares outstanding
(1.73 * 3/12) + (2.13 * 9/12) * 16.0
Target Net Income
Price Per Share

Total Purchase Price
Form of Consideration
Accounting Adjustments
Excess Purchase Price
Goodwill
Identifiable Intangible Assets
Amortization of Intangibles
Tax-Affected Interest Expense ($)
Pro Forma Shares Outstanding

Pro Forma EPS
Standalone EPS
Accretion/(Dilution)
Target Stock price * (1 + Premium) = Price per Share

20.00 * (1+ 0.25) = 25.00
Price per Share * Fully diluted shares
$25.00 * 16.0
Purchase Price * Percentage of each consideration
400 * 50% cash/debt
400 * 50% stock
Acquirors Shares + (Equity consideration / Acquirors share price)

63.0 + (200 / $85.00)
Pro Forma Net Income / Pro Forma Net Shares
(316 / 65.4)
4.75
(Pro Forma EPS / Standalone EPS -1) * 100
(4.83 / 4.75 -1) * 100
+32
331 Combined Income
-5 Amortization Expense
1.68% Accretion
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Breakeven Synergies Analysis
If a transaction is dilutive, it can be rationalized by the synergies that would be created by the
merger of the two companies
Breakeven synergies refers to the minimum amount of pre-tax income synergies needed for
the transaction to be non-dilutive
Both revenue and cost saving synergies exist, but mini-merger analyses generally focus on cost
synergies (the amount of money saved by eliminating overlap between companies)
In this mini-merger scenario, the result was accretive. However, if it had not been, the
following steps would have determined the breakeven synergies
Assume pro forma EPS had come out to $4.60/share
Step
Calculation
Addl EPS Required To Break Even
Standalone EPS Pro Forma EPS

$4.75 - $4.60
Addl After-Tax Net Income Required to Break Even
$9.81MM
Additional After-Tax Net Income / (1-Tax Rate)

$9.81MM / (1 - .40)
$.15
Addl EPS * Fully Diluted Shares Outstanding

$.15 * 65.4
Pre-Tax Synergies Required to Break Even
Result
$16.4MM
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The Mini-Merger Approach

Static Analysis Summary
The mini-merger approach is a static analysis that is based on a number of simplifying

assumptions. Nevertheless, the results provided by the mini merger are a good guideline for
an initial analysis
Features of the approach
For any given price/premium and form of consideration, the Mini-Merger Approach
allows the determination of accretion/dilution and break-even synergies
Adjusts for incremental depreciation, amortization, financing costs and dividend policy
Provides key pro forma credit statistics
Principal assumptions
Acquisition debt will remain outstanding for the entire period; i.e., no dynamic debt
paydown with cash generated by the combined entity
Model uses EPS estimates and some constant measure of shares outstanding to determine
the standalone net income numbers for acquiror and target; therefore, analysis is
incremental in nature
Profits and interest on refinanced debt of the Target will continue to be taxed at the
prevailing tax rate of the Target company (again, incremental analysis)
All intangible assets are amortized over the same useful life
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Tab H
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Multiple / Value Creation Analysis

Introduction
The reason that analysts focus on accretion and dilution is that stocks often trade off multiples
such as P/E
In other words, all things being equal, if earnings change and a stock trades off a P/E
multiple, the price of the stock should increase or decrease by the same percentage
These analyses can be performed on other multiples such as EBITDA or EBIT, but P/E is
the most common
Factors that influence what P/E multiple a stock trades at include projected earnings growth,
perceived risk, and general industry outlook
Based on these factors, the market may assign a different P/E to a merged company than it did
to the acquiror
The Value Creation Analysis attempts to capture the overall value impact of a potential
transaction to shareholders. While accretion/dilution analysis focuses solely on EPS impact,
the Value Creation Analysis also incorporates the P/E implications of a transaction (i.e.,
multiple expansion or contraction)
Impact of a transaction on the value for any given shareholder:
The Value Creation Analysis assumes that the share price is driven by P/E multiples
Using P/E valuation, share prices are impacted by:
changes in EPS (calculated in the Merger Analysis)
changes in P/E, also known as multiple expansion/contraction (qualitative assessment
of market reaction to the transaction)
It is therefore possible that a transaction which is dilutive to EPS can be accretive or
additive from a total value standpoint
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Introduction
The Value Creation Analysis attempts to capture the overall value impact of a potential
transaction to shareholders. While accretion/dilution analysis focuses solely on EPS impact,
the Value Creation Analysis also incorporates the P/E implications of a transaction (i.e.,
multiple expansion or contraction)
Impact of a transaction on the value for any given shareholder:
The Value Creation Analysis assumes that the share price is driven by P/E multiples
Using P/E valuation, share prices are impacted by:
changes in EPS (calculated in the Merger Analysis)
changes in P/E, also known as multiple expansion/contraction (qualitative assessment
of market reaction to the transaction)
It is therefore possible that a transaction which is dilutive to EPS can be accretive or
additive from a total value standpoint
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Example
There exists a breakeven

P/E multiple from a value
standpoint (to Target
shareholder)
Step 1: EPS Accretion/Dilution

Analysis
Although the transaction

looks dilutive to Target,
multiple expansion could
still make the deal
attractive to Target
shareholders
Pro Forma Net Income ($)

Pro Forma Shares
Once an exchange ratio is

fixed, in a stock merger the
split of value between
the two companies
shareholders cannot be
changed
Step 2: P/E Impact

We assume the new Company will trade between the standalone P/E multiples
PF
Value to
Market Acquiror 93%
Value
of PF MV
$
$
Value to
Target 7% of
PF MV
$
316
PF Net
P/E Multiple Income
$
x
PF
Price
$
65.4
12
316
57.96
3,791
3,525
265
Pro Forma EPS ($)
4.83
13
316
62.79
4,106
3,819
287
Accretion/Dilution to Acquiror (%)
1.68
14
316
67.62
4,422
4,113
310
Accretion/Dilution to Acquiror
Accretion/Dilution to Target
15
316
72.45
4,738
4,407
332
16
316
77.28
5,054
4,700
354
Pro Forma Net Income ($)
316
17
316
82.11
5,370
4,994
376
Target Share of PF Net Income
22.1
Multiple
18
316
86.94
5,686
5,288
398 Value
Expansion
19
316
91.77
6,002
5,582
420 Creation
20
316
96.60
6,318
5,875
442
% Ownership
# Shares of Target
16
PF EPS for Target ($)
1.38
Accretion/(Dilution) to Target (%)
Pro Forma EPS for Target

can also be obtained by
multiplying Pro Forma EPS
times the exchange ratio
(32.0)
EPS
$
# of
Shares
Net
Income
$
Market
Price
$
Market
Value
$
P/E
x
Acquisition
Price
$
Acquisition
P/E
x
Acquisition
Value
$MM
Exchange
Ratio
Ownership
%
Acquiror
4.75
63
299
85
5,355
17.9
5,355
93
Target
2.03
16
32
20
320
9.9
25
12.3
400
0.29
5,755
84

200611801956188

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NYIBDF13\162526\A2\11 JUL 2001\6:53 AM\1

MORGAN STANLEY DEAN WITTER

NYIBDF13\162526\A2\11 JUL 2001\6:53 AM\3

MORGAN STANLEY DEAN WITTER

Morgan Stanley Financial Definitions

Comparable Companies Analysis

Precedent Transactions Analysis

Discounted Cash Flow Analysis

Value Creation Analysis

Potential Impact of New Accounting Rules

Overview of Former Accounting Practices

NYIBDF13\162526\A2\11 JUL 2001\6:53 AM\4

Table of Contents (cont'd)

MORGAN STANLEY DEAN WITTER

Equity Capital Market Services

Fixed Income Capital Markets (FICM)

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MORGAN STANLEY DEAN WITTER

NYIBDF13\162526\A2\11 JUL 2001\6:53 AM\6

MORGAN STANLEY DEAN WITTER

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Summary of Valuation Techniques

Generally several valuation

Provides Companys implied value in the public

Reliability depends on the level of comparability of

Does not include control premium

Fully distributed trading value

revenue base (size)

Apply multiples derived from similar or comparable

Provides private market benchmark in a change of

Reliability depends on number of recent precedent

Apply multiples derived from similar or comparable

Leveraged Buyout Analysis

Determine the range of prices that a financial buyer

This analysis is heavily dependent on the cash flow

Check if there are any other sources of value in a

Different valuation techniques might apply

Project the Companys future operating cash flows

This analysis is heavily dependent on cash flow and

Net operating loss carryforwards (NOLs)

MORGAN STANLEY DEAN WITTER

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Applications of Valuation Techniques

MORGAN STANLEY DEAN WITTER

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Morgan Stanley Financial Definitions

MORGAN STANLEY DEAN WITTER

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Morgan Stanley Financial Definitions

The Basic Equations

= (EBIT - Int. Exp.) (1 - t)

MORGAN STANLEY DEAN WITTER

= Equity value (market)

= Price to earnings ratio (= price per share/earnings per share)

= Earnings before interest and taxes

= D/(D + EV), or leverage

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Morgan Stanley Financial Definitions

Dynamic Model Overview

- Operating Expenses (driver: margin, inflation)

+ Synergies (if any)

= Gross Profit (driver: margin)

Cash Flow Statement