ERM Provides Risk-Return Based M&A Evaluation Framework

A major company historically making a dozen acquisitions par year moves into a new sector. As part of its Enterprise Risk Management (ERM) system, it implements a method that allows it to compare different projects’ risk-return profiles and focus due diligence on the key risk-return drivers. For each investment prospect, key risks are identified and the values that they affect in the discounted cashflow (DCF) model are made variable over a confidence interval determined by subject experts. Simulations are run and a distribution of net present values (NPV) is obtained. The company can thereby clearly picture a project’s risk and return, and compare it to other prospects on a similar basis. In addition, the framework allows the company to focus on the most valuable due diligence activities or investments – the ones that are most cost-effective at reducing the confidence intervals of key project variables, thereby shaping the risk-return profile most optimally.

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