A banker valuing a target runs two engines side by side: what acquirers actually paid for similar companies, and what the target's own cash flows are worth today. The first looks backward at real deals; the second looks forward at projections. Both feed the football field the client sees.
Precedent transaction analysis, also called transaction comps or deal comps, values a target using prices paid in past acquisitions of similar companies. The logic is simple. If three rivals sold for roughly 9 times earnings before interest, taxes, depreciation, and amortization (EBITDA) last year, your target should command something near that, adjusted for differences.
Screening the deal set. A clean comp set comes from disciplined screening. Four filters do most of the work. Filter by industry so the businesses share economics and growth profiles. Filter by size, because a $200 million target and a $20 billion target trade on different multiples. Filter by timing, keeping deals recent (often within three to five years) so the multiples reflect comparable market conditions.
Common mistakes
- Starting unlevered FCF from net income. UFCF begins at EBIT × (1 − t), not net income. Net income already subtracts interest, double-counting financing when you discount at WACC.
- Forgetting the debt tax shield in WACC. The cost of debt must be multiplied by (1 − t). Using the pre-tax rate overstates WACC and understates value.
- Setting terminal growth above GDP. A of 5% or more implies the firm outgrows the economy forever. Keep at roughly 2% to 3%, below long-run GDP.
Bottom line
- Precedent transactions value a target on multiples paid in completed M&A deals, screened by industry, size, timing, and structure
- Acquisition multiples exceed trading multiples by a control premium, typically 20% to 40% over the unaffected price
- Strategic buyers pay more than financial buyers because they capture synergies; financial buyers are capped by return hurdles
- Unlevered free cash flow = EBIT × (1 − tax) + D&A − CapEx − change in net working capital
Exam shortcut
EV multiples for the whole firm, equity multiples for shareholders. When a question mixes debt levels across comps, reach for EV/EBITDA or EV/sales; they neutralize capital structure, while P/E does not. "Higher valuation method" is precedent transactions. Rank intrinsic and relative methods by the control premium: precedent transactions (with premium) usually top comparable companies (no premium). Terminal value drives the DCF.
The full lesson (about 2,869 words, 19 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- A7
- A8
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