BP Amoco Case Write Up
As long-term valuation is assumed, risk free rate is set as 30-year treasury rate, 5.73%. Cost of debt is 6.72% reflecting Amoco’s credit level. Cost of equity is calculated as 10.63%, leading to final WACC at 8.85% (Chart 1).
In DCF valuation (Chart 2), long-term growth rate is assumed to be 4%. Change in working capital is calculated as the average of 1997 and 1996 figure and is assumed to be constant for simplicity. Terminal value is valued at $69,398.1 million and NPV is $51,525 million. Stock price will be $37.07, indicating an exchange ratio at 0.46. This is a very conservative valuation as our DCF price is lower than Amoco’s current market price.
Regarding of multiple valuation (Chart 3), P/E ratio from comparable firms are used, which leads us to an exchange ratio at 0.68. Thus, our estimation for Amoco’s stand-alone value is from $37.07 to $54.69 per share, i.e. 0.46 to 0.68-exchange ratio.
As the acquirer, our basic negotiating strategy is to low the exchange ratio as much as possible. Based on our conservative evaluation of Amoco, our opening exchange ratio is 0.46. For Amoco sides, their opening exchange ratio is 1. The big difference between our opening prices indicates this negotiating process should be tough.
First, we checked the discount rate. For us, BP company, we use 8.83%, however, Amoco they use a higher one around 9%. The main difference to calculate the discount rate is that we use the 30-year Treasury rate as risk free rate compared to Amoco used 20-year Treasury rate. Moreover, we use the debt to debt plus equity but they use debt to equity to calculate WACC. To compromise these differences, we agree to use the average discount rate that doesn’t make a large influence of the valuation price. After this, we discussed the most important factor –growth rate. Based on the assumption in the case, we use 4% as terminal growth rate, 2% annual oil demand growth rate plus 2% inflation rate. However, Amoco hold the view that the oil price
In DCF valuation (Chart 2), long-term growth rate is assumed to be 4%. Change in working capital is calculated as the average of 1997 and 1996 figure and is assumed to be constant for simplicity. Terminal value is valued at $69,398.1 million and NPV is $51,525 million. Stock price will be $37.07, indicating an exchange ratio at 0.46. This is a very conservative valuation as our DCF price is lower than Amoco’s current market price.
Regarding of multiple valuation (Chart 3), P/E ratio from comparable firms are used, which leads us to an exchange ratio at 0.68. Thus, our estimation for Amoco’s stand-alone value is from $37.07 to $54.69 per share, i.e. 0.46 to 0.68-exchange ratio.
As the acquirer, our basic negotiating strategy is to low the exchange ratio as much as possible. Based on our conservative evaluation of Amoco, our opening exchange ratio is 0.46. For Amoco sides, their opening exchange ratio is 1. The big difference between our opening prices indicates this negotiating process should be tough.
First, we checked the discount rate. For us, BP company, we use 8.83%, however, Amoco they use a higher one around 9%. The main difference to calculate the discount rate is that we use the 30-year Treasury rate as risk free rate compared to Amoco used 20-year Treasury rate. Moreover, we use the debt to debt plus equity but they use debt to equity to calculate WACC. To compromise these differences, we agree to use the average discount rate that doesn’t make a large influence of the valuation price. After this, we discussed the most important factor –growth rate. Based on the assumption in the case, we use 4% as terminal growth rate, 2% annual oil demand growth rate plus 2% inflation rate. However, Amoco hold the view that the oil price