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Dear sir,
part c of doric question pilot paper regarding value of the new company under management buy out,
my issue is the depreciation, why is that included in a cashflow calculation? or if it is why after deducting it and calculating tax, it wasnt added back, please clarify me with the very existence of the depreciation calculation here being a non cash expense
The second sentence of the second paragraph below “The following additional information has been provided” says : “annual depreciation………is the amount needed to maintain the current level of activity”
What this means is that the need to spend the same amount as the depreciation in order to be able to maintain activity. So although we do add back the depreciation, there is a cash outflow of the same amount – the net effect of the two is zero.
1. spot on :)…thank you for the precision..it is all clear…so in summary all the calculated data eg revenue, cost etc are in cf terms, reaching CF before depreciation, i deduct the depreciation as the usual way to get the taxable cf, i apply the tax but after, here i don’t add back because adding the dep back would be cancelled anway, so to be practical don’t add back?
2. that depreciation it says in the answer it was calculated on the revalued amount, so its like the realisable value becomes that revalued amount?
Hi tutor,
In the same question, part c of management buy-out, to get the value of part’s division of doric they calculated using 6% instead of 11%
28.4/ 6%
Kindly explain?Thanks
Another question similar to Doric is evertalk from June 2003, in that question while doing restructuring, they have considered the interest saved upon cancellation of current bond, while in Doric there’s nothing like that, which approach is correct as there’s nothing written which says to include tax saving in cash flow, as cancellation actually have no impact on cash, both questions are almost same
Are you looking at the examiners answer to part c of Doric, because I really cannot see where you are finding 28.4/6% in it.
Evertalk is not similar to Doric. Doric is selling all or part of the business, whereas Evertalk is restructuring where debt is cancelled as part of the restructure and replaced by shares.
In Doric 3rd proposal is management buy-out, In the solution
Estimate of the value of new company:
cash flow before interest payment is 28.4m
Then it is written as:
Estimated value based of cashflow to perpetuity = 28.4/(0.11-0.05) = $473.3 m
While cost of capital is 11%, i want to ask why 5% is deducted from 11%Now 2nd question relates to adding interest saving from cancellation of debt, in Doric proposal 2 says to restructure, unsecured bonds are cancelled and replaced with ordinary shares, while calculating income position money saved from interest on debt due to its cancellation is not included as interest savings
while in Evertalk, in proposal of restructuring, bond are cancelled and ordinary shares are issued to existing bond holders, same situation as in Doric but
calculations of free cash flow of the company includes interest saving on existing bonds which are cancelled in restructuring
I want to ask why in 1 questions of restructuring they added interest saving and in the other they ignored,
ThanksI don’t know which answer to Doric that you are looking at, but the examiners own answer (which you can find on the ACCA website) shows the value to perpetuity as 33.4(1.035)/(0.11 – 0.035) = 461M
It is using the normal dividend valuation formula, which can be used to calculate the NPV of any growing perpetuity. Here it is growing at 3.5% per year, hence (0.11 – 0.035)
I repeat that Doric is not a restructuring. Proposal 2 makes no mention of restructuring – it is closing one division through a management buyout. There is no similarity at all between the two questions.
In Doric we are valuing the business on the basis of discounting the free cash flows at the WACC of 11%. Interest is never relevant in arriving at the free cash flows (because it is accounted for in the discounting at the WACC).
I’m sorry I just checked it out, there are 2 questions named Doric in the book, one is pilot papers questions and the other which I’m talking abt is December 2010 question no 1 Doric
But I’m creating a new topic with same questions to avoid confusion for others in future🙂
Now everything you have been saying makes sense – I thought one of us was going mad!!
The reason for subtracting the 5% is actually the same reason as I wrote before (except that the question says that the cash flow is growing at 5% (not 3.5% as in the pilot paper).
It is using the dividend valuation formula.MV = Do(1+g)/(Re-g)
You use the same formula to get the present value of any growing perpetuity, We are discounting at 11%, the growth rate is 5%, so on the bottom of the formula we have (11%-%%)
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