HomePractice Question: AcmeTech’s Acquisition of CyberSystems

Practice Question: AcmeTech’s Acquisition of CyberSystems

Scenario:

On 30 September 2023, AcmeTech acquires 100% of the equity of CyberSystems Ltd. The purchase consideration consists of:

  • An immediate cash payment of \$8,500,000 on the acquisition date.
  • A contingent payment of \$2,000,000 payable on 30 September 2024 if CyberSystems’ EBITDA margin exceeds 20% for the year ended 31 December 2023.
  • A further contingent payment of \$2,500,000 payable on 30 September 2025 if CyberSystems’ EBITDA margin exceeds 22% for the year ended 31 December 2024.

All indicators suggest these targets will be met. AcmeTech uses a discount rate of 8% per annum for present value calculations.

Required: Calculate the fair value of the investment in CyberSystems Ltd. on 30 September 2023, by determining the present value of each element of consideration and summing them.

Solution: Valuation on 30 September 2023

Scenario recap: AcmeTech acquires 100% of CyberSystems Ltd. on 30 Sep 2023. Consideration:

  • Immediate cash payment: \$8,500,000
  • Contingent payment of \$2,000,000 on 30 Sep 2024 (if 2023 EBITDA margin >20%)
  • Contingent payment of \$2,500,000 on 30 Sep 2025 (if 2024 EBITDA margin >22%)

Discount rate = 8% p.a.

1. Present Value of Each Element

Payment dateAmount (\$)Timing (years)Discount factor
(1 / (1.08)n)		Present value (\$)
30 Sep 2023 (today)8,500,00001.00008,500,000
30 Sep 20242,000,0001.00.9259261,851,852
30 Sep 20252,500,0002.00.8573392,143,348
Total PV of consideration12,495,200

2. Calculation Details

  • Discount factor for 1 year at 8%: 1 ÷ 1.08 = 0.925926
  • Discount factor for 2 years at 8%: 1 ÷ (1.08)2 = 0.857339
  • PV of 2024 contingent payment: 2,000,000 × 0.925926 = 1,851,852
  • PV of 2025 contingent payment: 2,500,000 × 0.857339 = 2,143,348
  • Immediate payment is not discounted (PV = 8,500,000)

3. Fair Value of Investment

Immediate payment8,500,000
PV of contingent payments3,995,200
Total fair value of consideration12,495,200

4. Key Assumptions

  • Both contingencies are considered probable and fully recognized at fair value.
  • Payments occur exactly 1 and 2 years after acquisition.
  • Discount rate of 8% p.a. reflects AcmeTech’s cost of capital.
  • No further adjustments (e.g., credit risk, timing differences).

Strategic Approach for Valuing Consideration with Contingent Elements

When you’re faced with an acquisition question that includes contingent consideration (earn-outs, performance payments, etc.), use this step-by-step method to ensure you capture every element correctly and arrive at the fair-value measurement on the acquisition date.

  1. Identify All Consideration Elements
    List every cash, share or other payment promised to the seller, including:
    • Fixed consideration (paid on closing).
    • Contingent payments (linked to future performance, time, regulatory approvals, etc.).
  2. Assess Probability of Payment
    Under IFRS 3 those contingent amounts that are probable must be measured at fair value.
    • If payment is virtually certain, include 100%.
    • If remote, measure at nil.
    • If in-between, estimate based on management’s best forecast or a weighted-probability model.
  3. Determine Timing (Cash‐flow Dates)
    For each contingent payment, pinpoint the exact date (or expected timing) when it will be paid:
    • One year, two years, milestone dates, etc.
  4. Select Discount Rate
    Choose the appropriate rate reflecting the acquirer’s credit risk and the time value of money (often the acquirer’s post-tax cost of debt or WACC).
    • Use the same rate for all contingent flows unless specific risk premiums differ materially.
  5. Calculate Discount Factors
    For each payment at time years, compute:
    DFn = 1 / (1 + r)n
    • r = discount rate (e.g. 7% → DF1 ≈ 0.935; DF2 ≈ 0.873).
  6. Compute Present Values
    Multiply each payment by its discount factor:
    PVi = Paymenti × DFi
    • Do this for the fixed (n=0) and each contingent payment.
  7. Sum to Total Fair Value
    Add the PVs of all elements to get the total consideration to be recognized:
    Total FV = Σ PVi
  8. Record Initial Measurement
    On consolidation date: Dr Investment in Subsidiary Total FV Cr Cash / Payables Fixed payment Cr Contingent consideration liab. Contingent PV Adjust as needed if the contingent is classified as equity under IFRS 3.
  9. Disclose Key Judgments
    In your IFRS 3 note, explain:
    • How you assessed probability.
    • The discount rate used.
    • Timing assumptions.

IFRS References

  • IFRS 3 paras B73–B78: Fair value measurement of contingent consideration.
  • IFRS 13 para B93–B98: Valuation techniques and discounting.