ohnson’s management believes that the most reliable way to value a potential target firm is by averaging multiple valuation methods, since all methods have their shortcomings. Consequently, Johnson’s Chief Financial Officer (CFO) estimates that the value of Jameson Limited, a potential takeover target could range, before an acquisition premium is added, from a high of $650 million using discounted cash flow analysis to a low of $500 million using the comparable companies’ relative valuation method. A valuation based on a recent comparable transaction is $672 million. The CFO anticipates that Jameson Limited’s management and shareholders would be willing to sell for a 20 percent acquisition premium, based on the premium paid for the recent comparable transaction. The CEO asks the CFO to provide a single estimate of the value of Jameson Limited based on the three estimates. In calculating a weighted average of the three estimates, the CFO gives a value of 0.6 to the recent transactions method, 0.3 to the DCF estimate, and 0.1 to the comparable companies’ estimate. Required: Calculate the weighted average value of Jameson Limited. Briefly explain why the CFO allocated a 60% weight to the ‘recent transactions method’, and only 10% to the ‘comparable method

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Question

ohnson’s management believes that the most reliable way to value a potential target firm is by averaging multiple valuation methods, since all methods have their shortcomings. Consequently, Johnson’s Chief Financial Officer (CFO) estimates that the value of Jameson Limited, a potential takeover target could range, before an acquisition premium is added, from a high of $650 million using discounted cash flow analysis to a low of $500 million using the comparable companies’ relative valuation method. A valuation based on a recent comparable transaction is $672 million. The CFO anticipates that Jameson Limited’s management and shareholders would be willing to sell for a 20 percent acquisition premium, based on the premium paid for the recent comparable transaction. The CEO asks the CFO to provide a single estimate of the value of Jameson Limited based on the three estimates. In calculating a weighted average of the three estimates, the CFO gives a value of 0.6 to the recent transactions method, 0.3 to the DCF estimate, and 0.1 to the comparable companies’ estimate.

Required:

Calculate the weighted average value of Jameson Limited.
Briefly explain why the CFO allocated a 60% weight to the ‘recent transactions method’, and only 10% to the ‘comparable method

Expert Solution

Step 1

Weighted Average

A technique known as a weighted average account for the varying levels of significance of the values in a data collection. Each number in the data set is multiplied by a predefined weight before the final computation is completed when calculating a weighted average. A weighted average, in which each value in a data collection is given equal weight, can be more accurate than a simple average.