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The valuation of mergers and acquisitions (part 2) – ACCA (AFM) lectures

VIVA

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  1. Hi John, thank you for the great lecture! Really inspiring.
    Just wondering, since we are given the cost of debt of A plc. is 7%, is there possible that we still can assume its debt beta is 0? I mean from 7% we can work out its required rate of return on debt is 7%/(1-25%)=9.33% and substitute it to the CAPM formula to get the debt beta at 0.1905 (which is not 0).
    By assuming debt beta is zero, we are assuming A plc. has its required rate of return = risk free rate, so that the cost of debt should be 8%*0.75=6% instead of 7% given in the question.
    Sorry I am confused here. Would you please kindly advising? Thank you!!

  2. Hi John, how will we calculate the discount rate if the business risk of the company being acquired is the same as that of the acquiring company, but there is a substantial change in the existing gearing of the acquiring company after the acquisition?

    • Almost certainly in that case the question would require you to take an APV approach, discounting at the asset beta to get the base case NPV and then adding the tax benefit on the extra debt being raised.

  3. I have not yet figured out…How could the cost of debt is lower than the risk-free rate?

    The cost of debt after tax relief they return to investors……. Sorry I didnt get it. Can you please elaborate it? Thanks

  5. Hi John – Your explanations of the steps in the valuation techniques in this course, and how to use these formulas are fantastic. Very clear explanations, and easy to understand. Thank you.

  10. Mr. Moffat In your lecture you said that the type 2 acquisition is a case where your business risk is affected but not your financial risk. The Acca book however has it the other way around by stating that the financial risk alone is affected. The book is a 2016 version. Can you ascertain which is correct. Thanks

    • No it should not.

      The question says that the cost of debt is 7% and therefore this is already after tax.

      As I explain in the earlier lectures (and in the lectures for Paper FM (old Paper F9)), the formula on the formula sheet only works for irredeemable debt, and Kd is not the cost of debt – it is the return to investors (which is pre-tax). When there is redeemable debt, then the formula on the formula sheet is not valid – the cost of debt is the IRR of the after-tax flows, which is not the same as Kd(1-t).

      • so that means that examiner in general is referring to redeemable debt. instead of making us calculate the kd for the company through the long winded procedure of IRR, the examiner directly states it as cost of debt(when he doesnt wish to specifically test us on that topic of IRR). In a nutshell if nothing mentioned and Kd given, then we assume the examiner is referring to redeemable debt with after- tax cost of debt given, right sir?

      • As I wrote in my previous, Kd is not the cost of debt it is in the investors required rate of return.
        If there is nothing else written in the question then we assume that the debt is irredeemable and therefore the cost of debt is Kd(1-T).

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