A Procedure for the Rapid Pre-acquisition Screening of Target Companies Using the Pay-off Method for Real Option Valuation

Abstract

Pre-acquisition target screening is a task that often needs to be made fast, but is still complex, especially due to the need to estimate the value of possible synergies arising from an acquisition. Acquisition synergies are highly uncertain, difficult to explicitly quantify, and require successful management actions to be realized. The valuation of synergies calls for methods that can handle both, high uncertainty and inexact information. This paper discusses how a rapid pre-acquisition screening of target companies can be performed with the pay-off method for real option valuation, treating the acquisition synergy as a real option available for the acquirer. The pay-off method is a simple, intuitive, and practitioner friendly method. We define acquisition synergy as the value arising from resource redeployments within the newly formed entity of the target and the acquirer, and as the value gained through the possible divesture of target company assets. The procedure presented can be used in the screening of prospective acquisition target companies.

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