Finance analysis Executive summary.edited

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Executive Summary This executive summary evaluates the financial status of the two companies and an analysis of the combined financial statement to offer an in-depth review of the combined financial outcome of Microsoft's acquisition of Activision. This report undertakes an in-depth evaluation of the financial position of both companies and the combined financial value derived from both firms. The valuation focuses on analyzing the balance sheet inc, one statement, and cash flow statements using financial ratios, discounted cash flow analysis, and costs of capital determination. The essence of these analyses is to determine the book strength of Microsoft in its acquisition strategy, the actual value of Activision to determine the financial commitment necessary for the acquisition, and the balance sheet strength of the combined business to provide an overview of the final financial strength of the combined business. This analysis is also intended to evaluate various financing models available to Microsoft and the costs of each, providing a recommendation of the most optimum and cost- efficient option for the acquisition. Mergers and acquisitions are an essential strategy in business growth, allowing the expansion of business operations without the more protracted process of incorporating new business or introducing a new product line. The importance of M&E has been in constant growth, with over 30,000 transactions taking place in 2004 valued at over $1.9 trillion (Kirkulak Uludag, 2013). However, these transactions have been typified by a higher failure rate, with as many as 44% of M&E deals failing to achieve the expected objectives of the acquiring entity and, by most accounts, leaving most managers in the target firms experiencing acculturative stress leading to a majority of them departing within five years of the acquisition (Kirkulak Uludag, 2013). The critical aspect of any acquisition undertaking is expanding operations to benefit from integration and economies of scale, creating wealth for the business owners. Most prior studies have shown that while the long-term benefits of M&E are questionable, the short-term returns are overwhelmingly positive. This is primarily through strategically targeting an organization whose financial and synergies are in line with the acquiring firm, which requires an in-depth analysis of the financial, processes, and organizational aspects of the firm to ensure that the deal reached is beneficial to the business owners in both firms in the short- and long-run. One of the most critical aspects of acquisition is the financial valuation, which forms the basis for the subsequent offer price and gives a glimpse of the potential future cashflows the acquiring firm may expect from their acquisition. Acquisition requires substantial cash and stock overlay, which can affect the firm's financial standing post-acquisition (Kirkulak Uludag, 2013). Valuation is the primary decision-making tool informing whether the acquisition is worth it and whether the company will realize its investment while the target company owners will attempt to optimize their return by valuing the company at the highest possible price. A more objective approach must be taken where the agreed-upon value is based on verifiable metrics. Dashboard Financial Performance.  Economic value added calculates – the estimated economic profit of a firm over and above the required return of a company when its return on the economic capital employed exceeds the cost of capital (Subedi & Farazmand, 2020). This analysis evaluated the EVA of the two firms and the EVA of the combined firm in case of a successful acquisition. For ache of the scenarios, ECA and total costs of capital are expressed as: For Microsoft, EVA represents 92% of the total capital Invested while in the case of Activision, EVA represents 66%. The combined EVA to Total cost of

capital is 4%. This means that it will take some time to align the synergy between the two firms to realize the higher economic value of the investments in the long term.  P/E Valuation – With a stock price of $221 and an Earning per share of $9.29, the Microsoft Price Earning ratio is 23.79. Activision, on the other hand, has a P/E ratio of 30.11 points to potentially an over-valuation. The P/E ratio for the combined business falls between the two ratios at 25.55.  Weighted Average Cost of Capital (WACC) – provides the blended cost of financing across all sources employed by an enterprise. It represents the average rate at which a company compensates its financing sources and is central in capital budgeting and business valuation (Mellen & Evans, 2018). WACC is traditionally computed using point estimates for each variable. Microsoft has a WACC of 8%, with Activision having the cost of capital at 6%. The combined financials with a 50-50 proportion of debt and Equity offers a WACC of 8%. This means the combined firm's return must exceed the 8% cost of capital to be a justifiable investment. Cost of Equity The Capital Pricing Model (CAPM) provides an expected rate of return on assets and investment, thus establishing a linear relationship between the expected rate of return on an asset or an investment and the risk (Chen, 2021). It is essential in this case, considering that an acquisition is one of the riskiest investment decisions a firm undertakes, with a substantial number of acquisitions failing to attain their intended goals. In this case, the expected returns for MSF, ITVI, and the combined financial are 8%,6%, and 8%, respectively. Microsoft's expected return at 8% is at par with the market rate. However, Activision's rate is two percentage points below the market rate, indicating a below Equity performance. The combined business, however, posted an at-market rate return and, as such, is an excellent investment to pursue. Discounted Cashflow DCF finds the present value of the projected future cash flows using a predetermined discount rate, in this case, the Weighted Average Cost of Capital (WACC), to determine whether the present value of these future cash flows is higher or lower than the value of the initial investment (Copiello, 2016). Microsoft has a Net Present value of the future cash flows at $331 billion, which is higher than the initial capital invested by $258 billion (331b – 72b) and is thus a good investment. Conversely, Activision posted an NPV of $13.2 billion with an initial capital of $ 3.8 billion, $9.4 billion higher returns. Finally, with a total capital invested of $76.2 billion, the combined firm posted an NPV of $344.2 billion, a positive return of $268 billion. The combined firm is a positive cash flow investment and can be considered a good investment. Ratio Analysis As part of an in-depth analysis, ratios offer a sneak preview of the companies' books by identifying and gleaning useful from the financial statement assessing Liquidity, growth, margins, leverages, rate of return, and more (Nadar & Wadhwa, 2019). Ratios offer a basis on which comparisons can be made between firms and performance can be tracked. Ratio analysis of the three firms found that:  Liquidity analysis - Activision has the highest Liquidity of the three scenarios with a current ratio and quick ratio of 5.208, meaning that its current assets can cover its current obligations five times over. Microsoft has current and quick ratios of 1.785 and 1.75, respectively. This indicates that the company can comfortably cover its

obligations with the current assets. The combined business has a current ratio of 1.869 and a quick ratio of 1.831, which is within the recommended range of 1.2 and 2.0 and is, therefore, within the safe threshold.  Microsoft has a net working capital of +74.6 billion, Activision of +10.1 billion, and a combined business of +84.4 billion.  Accounts receivables turnover – Microsoft has a ratio of 4.48, Activision has 9.06, and Combined business has a ratio of 4.58, all of which are sufficiently high to indicate efficiency in collecting debts. Activision has almost double the MSF ratio, indicating a lower debt default and write-off rate.  Inventory turnover – All firms posted a high IT ratio, except Activision, which posted zero inventory value in its balance sheet, possibly indicating that it cleared its inventory stocks by the close of business.  Total Assets Turnover – in all three cases, the firms posted a TAT of 0.3 and 0.6, with Activision posting the lowest ratio of 0.351 and the combined business posting the highest ratio of 0.549. This means that Activision has the lowest efficiency in utilizing assets to generate revenue, while the combination of the two increases the efficiency.  Debt to Equity ratio – the debt-to-equity ratio for the three firms are 0.435, 0.217, and 0.414 for Microsoft, Activision, and Combined, respectively, indicating that the balance sheet is financed by 43% debt at Microsoft, 21.7% debt at Activision, and 41.4% at the Combined business.  Equity Multiplier – Microsoft, Activision, and Combined EM are 2.191 and 1.424, respectively. In this case, Activision has the lowest financial leverage, with Microsoft being more indebted, resulting in a combined ratio of 2.049.  Time Interest Earned – when it comes to the ability to pay its debt obligation, MSF has a very high ratio of 40.4, while Activision has a ratio of 30.17, indicating that both firms have a sufficiently strong ability to repay their debts. The combined ratio is 79.89.  Net Profit Margin – MSFT, profit represents 37% of revenue, 30% at Activision, and 36% of revenue of the combined business.  Return on Assets – of the two companies, Microsoft is most efficient at utilizing assets to generate profit with a ratio of 0.2, with Activision posting a ratio of 0.11. The combined business, therefore, has a relatively high ratio of 0.2.  Return on Equity – Activision has an ROE of 0.153, MSF of 0.437, and the combined business offers a return of 0.41.  Book Value per Share – Generally, in all three scenarios, the BVPS stands at $22  Price to Book value – In all three cases, the stock trades at a premium with each PBV of 9.91, 3,18, and 6.56 for Microsoft, Activision, and the combined business, respectively. Conclusion The valuation shows that the acquisition is a sound financial investment as it improves the strength of the combined firm's balance sheet, albeit at a small rate. Activision has a low indebtedness, has a higher return on Equity, and offers a favorable price-to-book ratio, improving the whole business's outlook. However, some notable shortfalls must be reviewed in acquiring: the ability to pay debt obligation, a lower return on Equity, and a lower economic value addition. However, these considerations are compensated by positive metrics. Therefore, it is prudent to conclude that this acquisition is good for Microsoft and the combined business. References

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