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In requirements “a”, when calculating cash flow forecast for 3 year we didn’t include “replacement NCA investment”
In kaplan study text, it is written that “replacement NCA investment” is needed in order to continue operations at current level.if no information is available about amount then assume it is equal to current level of depreciation.
So, sir can you explain me why we didn’t include it in our calculation???
It is because Kodiak was set by the previous examiner, and he did not make this assumption.
The current examiner does make this assumption (as I stress in my free lectures on investment appraisal). Usually he states it in the question itself – in which case there is no choice, you must do it. When it is not stated in the question, he usually does make the assumption, but also makes it clear that you would still get full marks if you did not assume it but simply added back the depreciation (which obviously ends up with a different final result).
Sir
1) Why cost of equity was used as rate for discounting factor instead of cost of capital ????
2) If question ask me to estimate the value of the business based upon the expected “free cash flow to firm methodology” or “free cash flow to equity methodology” , then does it mean that i have to calculate “value of equity” in both method and this will be the “value of business” that question requirement was asking for ????
( my confusion regarding such requirement is that i don’t understand whether “value of firm” is the “value of Business” or “value of equity” is the “value of business” )
Two things:
Firstly, we always discount the free cash flows to equity at the cost of equity – this gives the value of the equity.
We always discount the free cash flows to the firm at the WACC – this gives the value of the whole business (equity plus debt).
(Do watch my free lectures regarding this.)Secondly, generally in the exam, the value of the firm is the same as the value of the business (and so the second of what I wrote above).
As I replied in my previous post, this question was set my the previous examiner and he was very often very poor with his wording. However, part (b) did specifically state to value it based on the free cash flow to equity and so it was I suppose OK of him.Again, the current examiner is much clearer in his wording as to whether we are expected to value the equity or the entire business (and it is most often in the context of acquiring another business, in which case it depends on whether or not the debt is being taken over).
Sir,
you said in your last comment that whether we are expected to value the equity or the entire business depends on whether or not debt is being taken over
i m trying to confirm few things related to last comment of yours
1) what does taking over debt by acquiring company means?
i m thinking that it means acquiring company will repay debt of target company2) If acquiring company takeover the debt of target company then we will have to calculate value of business as whole. As taking over debt means acquiring company will repay the target company’s debt. Then capital structure of target company will change and there will be 100% equity unless finance that were used to buy target company contain some debt. In Such case capital structure of target company will be how it was financed by acquired company after acquisition.
3) If acquiring company doesn’t takeover the debt of target company then we will calculate the value of equity as acquiring company will only pay for equity and debt will remain in capital structure of target company as it is.
Sir can you check whether i m thinking correctly regarding this three point. (Check whether it is correct or not. you don’t have to relate it to any math or question)
(Sir, i have watched your lecture i have no problem with topics, calculation. Problem that i mainly face is in understanding the requirement that what exactly i have to calculate. Once i figure that out its easy for me to do the whole thing. that is why i m troubling you so much and i m very sorry for that)
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