The valuation of mergers and acquisitions (part 1) - ACCA (AFM) lectures
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27 Comments
C
chinmayee·
hello sir
i had a doubt in example 2 as to why we are not deducting interest to calculate the tax figure? I understand that FCFF caters to both the equity and debt holders, but since interest is a tax deductible expense, shouldn't we first deduct it from EBIT and then calculate the tax, and then add interest later?
J
John MoffatTutor·
But we are told the tax in this question, so we do not need to calculate it.
A
aniruddh·
splendid explaination
M
moheikal·
Hi sir,
I think, DCF for year 4, should be discounted by 0.683 instead of 0.751 as per Q1 March 2020,.
J
John MoffatTutor·
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.
A
Akash·
Hi John,
Just on this point, we assume that the cash flows are occurring at the end of the year right? If that's the case, shouldn't the PV arrived at year 4 be discounted at 0.683?
J
John MoffatTutor·
It depends whether the question tells you the market return or the market premium. When you are given the market premium then this is the return on the market less the risk free rate. (So if the risk free rate is 5% and the market return is 15%, then the market premium is 10%)
J
John MoffatTutor·
You are welcome :-)
S
salvia cardosoSupporter·
Hi John,
Thank you for the very clear lesson.
I have a question... why isn't the loans repaid included in the equation.
J
John MoffatTutor·
You will have to say which equation / question you are referring to :-)
V
vaniapuddoo·
Hi John. In example 2, there is a loan repaid of 48. Any particular reason why we do not account for that?
J
John MoffatTutor·
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.
J
John MoffatTutor·
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 :-) )
J
John MoffatTutor·
You are welcome :-)
S
sadaf·
Sir in eg 2 the free cash flow of $228is the total value of the firm right and not the market value of the equity.
J
John MoffatTutor·
No - that is just the cash flow for the year.
The PV of the free cash flows will be the value of the firm (equity + debt) :-)
P
Pranav·
What is the reason for not deducting interest in Example 2. Earning are given before interest and tax, so we have to deduct tax and add back depreciation. Please explain
J
John MoffatTutor·
The after-tax interest is accounted for in the calculate of the WACC.
Just as when appraising projects we never include interest in the cash flows for the same reason.
S
salvia cardosoSupporter·
Hi John, why isn't loans repaid deducted?
J
John MoffatTutor·
It is when calculating the free cash flow to equity, but not when calculating the free cash flow to the firm.
J
John MoffatTutor·
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.
A
andrew·
hi john why don't we discount for four years because the qstn is saying from 4 yrs to infinity
J
John MoffatTutor·
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.
H
herafatima·
Hi John, the values are not given for example 2; free cash flows; in the lecture notes. can you please reply back with the question.
Regards,
J
John MoffatTutor·
Download the notes again - they were re-uploaded a few weeks ago.
H
herafatima·
Thanks :)
J
John MoffatTutor·
Correct (although you don’t really need to show the split – just don’t add back the depreciation, but do subtract any additional investment).
i had a doubt in example 2 as to why we are not deducting interest to calculate the tax figure? I understand that FCFF caters to both the equity and debt holders, but since interest is a tax deductible expense, shouldn't we first deduct it from EBIT and then calculate the tax, and then add interest later?
I think, DCF for year 4, should be discounted by 0.683 instead of 0.751 as per Q1 March 2020,.
In Q1 of 2020, the flows are from year 5 onwards (not year 4) and the answer is then discounted for 4 years.
Just on this point, we assume that the cash flows are occurring at the end of the year right? If that's the case, shouldn't the PV arrived at year 4 be discounted at 0.683?
Thank you for the very clear lesson.
I have a question... why isn't the loans repaid included in the equation.
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.
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 :-) )
The PV of the free cash flows will be the value of the firm (equity + debt) :-)
Just as when appraising projects we never include interest in the cash flows for the same reason.
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.
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.
Regards,