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Sarah Curie, a wealthy individual, has an investment strategy where she buys underperforming companies, sells off the worst performing divisions within them, introduces new lean processes and new management, and then sells them at a gain three to five years later. She currently has 50 such companies in her portfolio.
Sarah’s latest target acquisition is Plank Co, an electrical consultancy business company owned and run by Max Lorentz. Max has agreed to the sale as he has suffered from ill health recently and wishes to retire and travel the world while he still can.
Sir for this question sarah buys the whole businesses so we if calculate the market value using discounted future cash flows, they should be before tax right?
Compared with if she bought only the shares we wud have done after tax?It depends whether or not the companies still retain their status as companies. If they do then they will be subject to tax and therefore we should use the after-tax flows.
Ok I get that, an obvious one.
But as the bpp text says:
If the proposal is to buy the equity shares only, the cash flows should be cash flows after interest payments on debt of the target company and tax on the profits.
If the proposal is to buy the entire business, including liability for its debts, the cash flows should be cash flows before interest payments on debt of the target company.
What do u suggest they r trying to say?
I have no real idea what they are trying to say (and it seems pretty pointless anyway for Paper F9).
I would need to see the context in which it was written, but I do not have a BPP Study Text – only their Revision Kit.
It was written in context of discounted cash flows being to calculate market value of business
From the bpp text
“A DCF method of share valuation may be appropriate when one company intends to buy the assets of another company and to make further investments in order to improve cash flows in the future. The steps in this method of valuation are:
Step 1 Estimate the cash flows that will be obtained each year from the acquired business. The cash flows may be estimated for a maximum number of years (say, for ten years). Alternatively, there may be an assumption about annual cash flows from the business into perpetuity. If the proposal is to buy the equity shares only, the cash flows should be cash flows after interest payments on debt of the target company and tax on the profits. If the proposal is to buy the entire business, including liability for its debts, the cash flows should be cash flows before interest payments on debt of the target company.
Step 2 Discount these cash flows at an appropriate cost of capital. This produces a value either for the equity shares or for the business as a whole.”
The whole topic from bpp text
What they have written is perfectly correct – if they are taking over the debt then take the cash flows before interest, if they are not taking over the debt then take the cash flows after interest.
However this is not really particularly relevant until P4 – in F9 the question will effectively tell you what to do.
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