M&A Case Study - Return on Invested Capital
- 03:30
Calculate the return on invested capital (ROIC) for an acquisition and compare it to the cost of capital (WACC). Learn how to adjust the ROIC for the synergies and the timing of the deal.
Transcript
We've got a couple more things to do. We want to look at the return on invested capital. And this is another metric that's actually quite popular and increasingly popular. So what we're going to do is look at actually what we paid. So we're gonna get the acquisition equity value from the sources and uses of funds. We also paid some fees. And then I want to pull in the net debt as well, which is the net debt in the target. So this is the invested capital in the target and we're using not the book values because we're paying the equity value at market prices. So Coca-Cola invested in aggregate 89 billion. What are they getting as a return on that? In this case, if we take our EBIT number from the forecast model in the first forecast year, and I'm gonna multiply it by FX, that will give me my EBIT number. And then I'm going to add in the synergies. And the synergies I'm gonna pull from up above. We've got a synergy number, pre-tax number, and then we go to calculate the net operating profit after synergies. So what I'm going to do is I'm going to multiply the numbers above by one minus the tax rate because what I want to do is calculate my NOPAT, which is EBIT plus the synergies, and then I'm going to multiply that by 1 minus the tax rate. And I'm just going to use the targets tax rate here, the marginal tax rate of 23% and that will give me my NOPAT with synergies and NOPATs always on an after-tax basis. So I'm gonna calculate this as a percentage of what I invested. So that's giving me a return of 3%. Now bear in mind that the synergies haven't had a full run rate because we build them up over time. So it's a little unfair to include only one year. The problem is that doing this in multi years is that your investor capital does change. because if you reinvest earnings in things like property, plant and equipment and working capital, then you need to factor that incremental investment in the invested capital. So what I could do is I could come up and I could say, well let's assume that our synergy run rate, if I go to the syn assumptions, isn't 20, 50, 100, let's make it 100 percent in all three years. What we should see is a significant Improvement in that and it is significant 3.7, it's still not that meaningful and if we compare it to our cost of capital from the WACC sheet, this is what investors expect as a return from investing in this business. They expect 6.5%, but we are delivering from this acquisition 3.7% even with a full run rate of synergies. So this is potentially a negative to investors thinking about the transaction.