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Hi,
I understand that when we are considering buying a business that will cause a change in financial risk of the buyer, the APV method should be used to value the target. On the other hand when business risk is changed, there is no need to use APV as we can just use beta to calculate cost of equity and WACC
However, I dont understand why in the examples in the study text on this section, the buyer is using additional debt to buy the target which is a company in a different industry, which means not only business risk is changed but also financial risk. However the method they used to calculate the value of the target is not APV, but just use the normal business risk change method (ungear and regear beta) for valuation of the target
Hope you can help clarify.
Thank you
It very much depends on exactly what the question is asking for, and in the exam the approach is usually specified in the requirement – either to take an APV approach, or alternatively asking you to take a free cash flow approach.
More often than not, the question is asking for the maximum premium to offer for the company (or words to that affect) and there is synergy involved. In which case it is necessary to value the ‘combined’ company after the acquisition (usually using the total free cash flows discounted at the new WACC) and compare with the total of the values of the two companies before the acquisition.
It is not really possible for me to say more without seeing the exact questions, but I do not have either the Kaplan or the BPP Study Texts – only the BPP Revision Kit. If you come across the problem in either a past exam question or a question in the BPP Revision Kit, then do ask again and I will be able to give you a more precise answer.
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