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Dear John,
When using Free Cash Flow to value an acquistion target, there are generally two approaches: one is to use net operating profit before interest after tax, discounted at WACC to calculate total value of the firm, then deducted by its debt to calculate net asset value. The other is to discount NOPAT (interest included) at cost of equity.
In the case of Pursuit, I followed the first approach and it appears to be also what model answer has suggested. I have a specific question about what ‘market value’ of a firm really is. Usually when come across the term “market value”, I would presume it is the company’s “net assets”, or alternatively its the equity value. In this case however, the answer seems to use the ‘total asset’ (equity and debt) value of Pursuit, and Fodder to calculate combined beta, and also acquisition synergy. This is quite different from other questions, where they consistently apply equity value.
Will I get full mark if I use equity value of both companies in the above calculation?
Thanks!
You would get full marks. You are right in saying that the examiner has been a little inconsistent when combing betas. I think more correct is to use equity values (simply on the basis that equity carries the risk) but there are arguments both ways. The examiner will have to accept either.
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