8. Sources and Uses of Funds

Overview

In this lesson, we complete a Sources and Uses of Funds Table for the transaction. This simple calculation is complicated by the cash available on the target's balance sheet.

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Summary

  1. Lesson Goal (00:04)

    The goal of this lesson is to complete our transaction assumptions and create a sources and uses table.

  2. Assumptions for Fees and Taxes (00:11)

    The following fees are included in our merger model:

    • Advisory fees: These are paid to bankers for arranging the deal. They are a percentage of the total equity price.
    • Debt issuance fees: These are paid to lenders for raising debt. They are a percentage of the total debt issued. In this model, we assume that these fees can be amortized over several years in the Income Statement.
    • Legal fees: These are paid to lawyers for facilitating the deal. They are typically a smaller percentage of the equity value than the advisory fees.

    We also need to create an assumption for the tax rate. If the tax rate is different for the two companies, then it’s best to use the acquirer’s tax rate.

  3. Minimum Cash Balance Assumption (01:05)

    We need to create an assumption for the combined minimum cash balance. We do this by adding the minimum cash balance for each company. Generally, we won’t know what these minimum cash balances are unless we can speak to the CEO or CFO of the companies. As a result, we need to make an assumption. Generally, the combined minimum cash balance is a function of revenue, so whichever company has higher revenue will have a higher minimum cash balance.

    After determining the combined minimum cash balance, we calculate the combined cash in both companies by adding the cash balances from both Balance Sheets. We also subtract the amount of cash being used in the deal. By comparing this combined cash balance to the minimum cash balance, we can see if there is any excess cash that can be used to fund the deal.

  4. Creating the Sources and Uses Table (02:26)

    The Sources and Uses table indicates all the sources of funding that will be used in the deal, and all the uses for that funding. The relevant figures can be found or calculated from the transaction assumptions. In our model, there are four sources of funding:

    • Cash Used: This is found in the transaction assumptions.
    • Debt Issued: This is found in the transaction assumptions.
    • Stock Issued: This is the percentage of the transaction funded by stock multiplied by the total equity price.
    • Excess Cash Used: This is the difference between the combined cash balance and the minimum cash balance. Alternatively, if not all this cash is needed, this is the difference between the total uses and all the other sources.

    In our model, there are four uses for the funding:

    • Equity Purchase Price: This is the price of the target company.
    • Refinance Acquirer’s Debt: This is the acquirer’s current amount of debt.
    • Refinance Target’s Debt: This is the target’s current amount of debt.
    • Transaction Fees: This is the sum of the advisory fees, debt issuance fees, and legal fees.

    The total amount of sources in this table should equal the total amount of uses.

Transcript

In this lesson, we're going to complete our transaction assumptions so that we can create our sources and uses table.

Let's start by filling in our assumptions regarding advisory fees. These are the fees paid to bankers for arranging the deal, and we've been told that these are 1.4% of the total equity price.

The debt issuance fee is paid to the lender for this transaction, and the debt issuance fee is 3.1% of the total amount of debt issued.

This debt issuance fee can be amortized in the income statement over seven years. And finally, we have legal fees, which are typically less than advisory fees, and what I'm going to assume to be 0.6%.

Next, we have the tax rate.

If you have companies where the tax rate is very different, it's best to go with the acquirer's tax rate, which in this case is 37.2%. And lastly, we have the combined minimum cash balance.

It's hard to know what the actual minimum cash balance is in each of these companies, without actually being the CEO or CFO of these companies, but I'm going to assume a 50 million cash balance for Shirt Shop, and a 13 million cash balance for Trouser Town. This creates a total of 80 million. Typically, the combined minimum cash balance will be a function of revenue. Let's now compare this to the cash balance in both companies before the deal.

And to do this, I'll take cash from both balance sheets.

So, in the acquirer, I'll scroll down, and take the cash balance.

And I'll add to this the cash balance for the target.

And this shows me that my cash balance is far above the minimum cash balance, and this excess cash can be used in our sources and uses table.

In this combined cash balance, I should subtract any cash that's being used in the transaction.

So I simply subtract, cell I-16.

I'm now ready to create my sources and uses table. Let's scroll down to begin, and I'll start on the sources side.

I'll quickly include cash, debt, and, of course, shares.

As you include shares, I'll simply take the percentage, multiply by the equity value.

Now, I can also use excess cash based on the combined cash balance of both, but I'll leave this cell blank and calculate this later, once I've calculated total uses, which, of course, will be the equity purchase price, the acquirer's debt, and the target's debt, and the transaction fees. To get the acquirer's debt, I'll simply jump back into the balance sheet.

I'll do the same for the target's debt, and as you might remember, there's very little debt on this particular balance sheet, only 5.2 million.

And then lastly, we have transaction fees.

So we'll start with the advisory fee, multiplied by the equity value, plus the legal fee, again multiplied by the equity value, and then lastly, the debt fee multiplied by the amount of debt issued.

And I'll simply do a sum to find the total uses.

And now I can use my excess cash to make up this particular difference. And the excess cash will equal to the minimum value of the total uses, minus the rest of the sources, or...

the combined cash balance minus the minimum.

And if I sum all my sources, thankfully, I can see that the difference between the combined cash balance and the minimum cash balance is much greater than the difference between all my other sources, and my total uses. In the next lesson, we'll progress on to creating a combined income statement for Shirt Shop and Trouser Town.