Mergers & Acquisitions - a Real Option valuation approach of investment decision under uncertainty

MA-Thesis / Master von Marc Zajicek

Abstract:

The objective of this dissertation is to examine the application of Real Options for the evaluation of companies with regard to acquisitions. There has been an intensive scientific discussion in the past years about the Real Options method for the evaluation of investments and mergers & acquisitions as in practice usually the management tries to capture future developments with static methods of capital budgeting. For example, future cash-flows are discounted with a fixed risk-adjusted discount rate. Therefore, the Real Options approach has been applied very rarely as it has the reputation of high complexity and poor practicability in daily business. However, the use of present values and capitalized values may produce pitfalls in acquisition decisions as strategic investment decisions might be characterized by a wide range of possibilities to react flexibly to a fast changing environment.

In chapter 1, the term Mergers & Acquisitions (M&A) is defined and the motives as well as the relevance of M&A transactions for different branches are described in detail. Furthermore, the process and the different phases of a merger or an acquisition are explained.

Chapter 2 presents traditional evaluation methods of static net present value, sensitivity analysis, Monte Carlo and decision tree. These classic methods are discussed and a comparison is drawn among these techniques in regard to practicability. At the end of this chapter, a evaluation is presented in regard to specific situations with the mayor parameter of uncertainty and flexibility for the application of these classic methods.

The basic concept of option pricing is described in chapter 3. In addition, the Black-Scholes equation and the underlying assumptions are explained in detail in order to understand financial options, which are the basic for the Real Options approach. At the end of the chapter, an example of a call and put option is discussed in order to understand the functioning of options.

Chapter 4 presents an introduction and definition of the Real Options method. Furthermore, the value drivers and the value creation due to the application of Real Options are discussed and analyzed in detail. After the discussion of the functioning of Real Options, a comparison of the analogy between financial Options and Real Options is done in order to possible differences. In this context, the limitations of the analogy of financial and Real Options are presented. Finally, the classification of Real Options in regard to managerial flexibility in different situation and option for company is discussed.

The chapter 5, a comparison of the Real Options and DCF method is done. From the lessons learned of this and previous chapters, the problems of the application of Real Options in practice is explained in detail. The end of this chapter is the presentation of a case study with the application of Real Options and DCF in order to show mayor differences in the evaluation perspective of investment opportunities by applying these methods and possible contrary results.

Last but not least, chapter 6 present the application of Real Options with M&A transactions. Here the specific classification of Real Options in regard to M&A is presented and a applied case study of Microsoft’s acquisitions in the past is described and analyzed. Finally, the results are discussed in regard to the relevance of the evaluation of acquisitions by the Real Options approach.

At the end of the dissertation, a conclusion is drawn in regard to the topic and the fulfillment of the given objective of the diploma thesis.

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