The valuation of mergers and acquisitions (part 2) – ACCA (AFM) lectures
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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.
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
ah because of tax relief, the cost of debt can be lower than the risk free rate??
Correct. The pre-tax cost of debt will be higher the same or higher than the risk free rate, but after tax it can be lower 馃檪
mattlloyd: Thank you for your comment 馃檪
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.
Shortarse: you can download them from the ACCA website (look in study support).
Where can I find the Sep/Dec 2015 Flufftort exam Question? Thanks
Hi John,
How can we judge that the cost of debt given in a question is after tax or not ? Please give me techniques about it.
The cost of debt to the company is always after tax, unless you are specifically told that it is pre-tax.
sir, in example 3 .what if i calculated asset beta of Aplc fist..?
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
Describing them as type 1, type 2, or type 3, was removed from the syllabus last year.
Sir, in example 3, should it be Kd*(1-T) (equals to 7%*0.75) when calculating the WACC according to formulae given?
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).
Thank you, sir
You are welcome 馃檪
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).