Embedded derivatives: A high-tech electronics manufacturer divested a foreign subsidiary using an investment agreement that contained complex put and call options requiring bifurcation for financial reporting purposes. We helped the company and its board to understand the fair value components of the investment agreement and potential future earnings-per-share impact due to quarterly mark-to-market. To fully capture the intricacies and inter-relationships among the put and call options, our valuation analysis combined a binomial model and Monte-Carlo simulation. Our methodology produced defensible results while saving cost and time for our client.
Management compensation incentive plan: An online financial data services provider, was acquired by a private equity firm using a complicated management compensation incentive plan. We helped value a specific class of common stock issued under the incentive plan, for both financial reporting and tax planning purposes. To fully capture the priority of fund distribution to all securities on the capital structure, we utilized an advanced option based framework to estimate the fair value of the common stock and the incentive compensation. Together with our in-house tax specialist, we provided a comprehensive service to our client.
Hedge-effectiveness testing and swap valuation: A large insurance company used a large portfolio of cross-currency and interest rate swaps as cash flow hedge against fluctuations in the value of fixed-income bonds in their structured investment vehicles. We helped identify the instruments that qualified for hedge accounting, estimated the fair value of the swaps and performed hedge effectiveness testing using regression analysis. Several complex issues, such as options embedded in the debt instruments, were analyzed. We also provided continuous training by explaining the methodology used in the analysis and guided the client in the procedures needed to update the analysis in-house.
Contingent consideration (earn-out): A pharmaceutical firm acquired a research laboratory developing promising new compounds to treat disease. Only a small portion of the acquisition price was paid up-front; the majority was tied to various research and regulatory milestones and sales goals. The sales-related payments were particularly complex because they included lump sums and royalty rates based on aggregate sales over 12 years. We developed a probability matrix to reflect the various possible outcomes and tied that to an option-pricing Monte Carlo sales simulation based on management's forecasts. The resulting valuation captured the contingent consideration's unusual risk characteristics and helped management see the potential income statement effects of future possible outcomes.