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Thank you, as always for your very prompt relies and sorry if I have strung it out a bit
This is probably where I’m confused – the debt lenders did put money in
because how else did their value go from (50% of $140) $70 to (50% of 189) $95 and market value includes that debt – value of firm belongs to D & E
As per the question “assuming the combined company’s capital structure stays the same as that of P’Co’s current capital structure” i.e. 50:50“The reason is that any gain in the total market value goes to shareholders (not to debt)”
I’m not sure I agree/understand – surely if debt holders put more funds into the company, then the increase in market value (value of firm debt + equity) belongs to debt holders.
In this case the question doesn’t say what the debt holders put in but their proportion post acquisition is 50% of the actual value of the firm which suggest they put in (95-70) $25 extra funds – the other 50% is owned by the equity holders.
Alternatively, how can the debt holders have the same proportion (50:50 market values) of a much larger entity without increasing their value?
This is why I can’t understand why comparing; Value of Firm with Value of Firm applies to Equity holders only when I believe the comparison should be value of equity with value of equity to arrive at impact on shareholders
Please helpThe question asks “whether the acquisition of F’Co would be beneficial to P’Co and its shareholders”
Given that the shareholders own P’Co then it really means the shareholders as there can be no change in the debt holders value – their loans are unchanged.
So what I can’t understand is that the solution compares the Value of Firms – P’Co & F’C when it should be comparing Equity Values (I think?)
For example
P’Co’s pre-acq Equity Value is $70m. It pays $49m for E & D values of F’Co which is now all equity. So its ‘cost’ of combination is $119m
Compared to its combined equity value (given that the Ke was calculated using 50:50 gearing) is 50% of $189 = $95k. It would seem to me that P’Co’s shareholders have lost (95 – 119) $24m
Please help!“Co will repay £3m of the outstanding loan at the end of the year”
The outstanding loan at the end of the year should include the interest charge for the year?
If this is so, then the balance at end of year 1 (65+5.85-3) 67.85 and the interest charge for year 2 (9%) = 6.11Part b) Option ii) Coupon Rate – I used the IRR approach as follows:
Yr. C/F DF (5%) PV DF (10%) PV
0 (95.71) 1 (95.71) 1 (95.71)
1–5 5.00 4.329 21.65 3.791 18.96
5 100 0.784 78.40 0.621 62.10
4.34 (17.65)IRR formula 5 + 4.34/21.99 x 5 = 5.99% = rd = coupon rate when nominal value = market value
Would this have been acceptable?
Yes and thank you, I understand now that in both cases the discounting each year is at the spot yield curve for that year. However, it is the cash flows that are confusing me
First article; cash flows based on coupon rate and redeemable value (5 + 105)
Second article; cash flows, based on the compounded Spot Yield Curve, the bank is quoting Annual Forward Rates p.a. as follows:
Year1 3.5% + Year2 5.71% which is 4.6% each year = Yield Curve Year 2
Yr1 3.5%, Yr2 5.71% + Year3 7.02% which is 5.4% each year = Yield Curve Year3 and so on.
Cash flows based on the Annual Forward rates i.e. compounded Yield Curve results in fixed interest of 5.68% but if based on the actual Yield Curve it would be 4.58%.
If I’m correct in thinking that the Annual Forward rates = compounded Yield Curve then I guess is why compounded? or do I need to know?I have also attempted P4 four times. First time in Jun 2014, having passed P2 and P3, I was concentrating on passing P1 and could not make up my mind whether to choose P4 or P5. Having had an exemption from F9 (?) I decided to have a go at P5 as it was more mathematical. It was totally foreign to me but I stuck with it knowing that I would fail. However, if my fail wasn’t a complete disaster i.e. mid 30’s or above, then this would be the paper for me. I got 39 and passed P1 – great just P4 and P6 (my favorite subject) left to do. I decided to concentrate on P4 for Dec 2014 and also cover the basics of P6, thinking that P6 would be relatively easy in Jun 2015. Anyway I passed P6 (surprise) and got 30 marks for P4 (no surprise as I knew I did badly). Now only P4 left so worked hard for Jun 2015 – result 38 (one mark less than when I practically knew nothing about the subject) and had expected mid 40’s. Worked even harder for Sep 2015. Exam did not seem particularly difficult or time pressured and expected a clear pass. My result was in the low 30’s!
As I have never beaten my first attempt, I could easily come to the erroneous conclusion that P4 is a farce and the marking (system) is a lottery, which of course is not true as I’m going to do it again in Dec 2015!