What is the net present value formula for a merger or acquisition?

1 What is NPV?

NPV is the difference between the present value of the benefits and the present value of the costs of a project or investment. Present value is the value of a future cash flow in today's terms, discounted by a certain interest rate or discount rate. The discount rate reflects the opportunity cost of capital, or the rate of return that you could earn on an alternative investment of similar risk and duration. A positive NPV means that the project or investment is profitable and adds value to your company. A negative NPV means that the project or investment is unprofitable and destroys value.

2 How to calculate NPV?

The basic formula for NPV is: NPV = PV(Benefits) - PV(Costs) To calculate the PV of the benefits and costs, you need to estimate the future cash flows from the project or investment and discount them by the discount rate. The cash flows can be either inflows or outflows, depending on whether they generate or consume money for your company. For example, if you are acquiring another company, the benefits could include the expected revenues and cost savings from the merger, while the costs could include the purchase price and the integration expenses.

3 How to choose the discount rate?

The discount rate is one of the most important and challenging inputs for NPV calculation. It reflects the risk and return characteristics of the project or investment, as well as the opportunity cost of capital for your company. There are different methods and sources to estimate the discount rate, such as the weighted average cost of capital (WACC), the capital asset pricing model (CAPM), or the market rates of similar projects or investments. The choice of the discount rate can have a significant impact on the NPV and the decision to accept or reject a project or investment.

4 How to interpret NPV?

The NPV tells you how much value a project or investment adds to your company, in today's terms. It also helps you compare different projects or investments and choose the one that maximizes your company's value. Generally, you should accept a project or investment if its NPV is positive, and reject it if its NPV is negative. However, there are some limitations and assumptions that you should be aware of when using NPV, such as the accuracy and reliability of the cash flow estimates, the sensitivity and variability of the discount rate, and the timing and relevance of the cash flows.

5 How to use NPV for a merger or acquisition?

To use NPV for a merger or acquisition, you need to estimate the PV of the benefits and costs of the deal, and subtract them to get the NPV. The benefits could include the synergies, or the value created by combining the two companies, such as increased revenues, reduced costs, or improved market position. The costs could include the acquisition price, or the amount paid to the target company's shareholders, as well as the transaction and integration costs, such as fees, taxes, and restructuring expenses. The NPV of the deal tells you how much value the merger or acquisition creates for your company, and whether it is worth pursuing or not.

6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?