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The valuation of mergers and acquisitions (part 1) – ACCA (AFM) lectures

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    • No. 0.751 is correct and I explain why in the lecture (and is explained in the printed answer). Using the dividend valuation formula for years 4 to infinity gives a PV in 3 years time, so this needs then to be discounted for 3 years.

      In Q1 of 2020, the flows are from year 5 onwards (not year 4) and the answer is then discounted for 4 years.

  3. Hi Sir, as we know the formula for computing the cost of equity under the CAPM method is: Ke = Rf + Equity beta * (E(rm) – Rf).

    However, in practicing other questions, particularly valuation questions, I notice that in the answers, the Rf rate is not deducted from the E(rm) as required in the formula. Do you have an idea why this is so?

      • Hi John. In example 2, there is a loan repaid of 48. Any particular reason why we do not account for that?

      • The free cash flow is the cash available for all lenders (i.e. equity and debt).

        However when we are asked for the free cash flow to equity (as in example 4) then we are after the cash available just for the equity and then we will subtract anything going to debt.

  5. Hi John, not sure if this is the correct place to ask this. If we have a cash flow which increases in perpetuity like in the above example, how would we account for tax on this cash flow? Would it be the same as years 1 to 3 by simply taking the cash flow and deducting tax? Thanks in advance.

    • It depends on the timing of the tax. If tax is payable without any delay then yes – you would take use the cash flow less tax.
      However if (as is more likely) there is a one year delay in the tax, then you need to calculate the PV of the cash flow before tax, then get the PV of the tax flows by multiplying the PV of the before-tax cash flows by the tax rate and discounting this figure for one year.

      (It is OK asking here except that I don’t always see comments here. So better is to ask in the Ask the Tutor Forum – I always see questions posted there and so always answer 🙂 )

    • Free cash flow is before interest (just as we ignore interest in Paper FM (was F9) when appraising projects. We discount at the WACC (which takes account of the cost of debt) to get the value of the business.

      The free cash flow to equity is after interest, and is discounted at the cost of equity to get the value of equity.

      I do explain all of this in the free lectures.

    • Multiplying by 1/r give the PV at time 0 of a perpetuity starting at time 1.

      Since the prepetuity starts 3 years late (at time 4 instead of time 1) multiplying by 1/r gives a PV 3 years late – at time 3 instead of time 0.
      So we need to discount for 3 years.

  12. Hi John,

    For the FCF formula, Is the amount needed to replace non-current asset considered as capital expenditure? If yes, does that mean we separate total capex investment into 2 part, one is to replace current depreciated fixed asset (of which equal to depreciation), and the other part is to invest additional fixed asset?

    Thank you

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