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Dear tutor,
when we have to calculate cost of equity to find the value of fodder co. I was ungearing the existing beta equity of fodder co and was then regearing it with existing level of gearing of pursuit co. can you please tell me what shall i do as examiner has used the existing cost of equity of 1.53.
please find the attached linked of the examiner question and answer here:https://www.accaglobal.com/content/dam/acca/global/pdf/p4_june_2011_qu.pdf
https://www.accaglobal.com/content/dam/acca/global/pdf/p4_2011_jun_a.pdfI was taking the ungearing ke in order to incorporate the financial risk pursuit co. has to face but in examiner answer it has not been done.
I don’t understand why you say that the examiner has used the existing cost of equity.
The question says that the asset beta will be the weighted averages of the asset betas of the two companies – which he has done.
The question also says that the combined company’s capital structure will stay the same as that of Pursuit Companys current capital structure, and he has used that to calculate the equity beta and therefore the cost of equity.
Hi John,
In this question when calculating the free cash flow of Fodder Co, the operating profit is after operating costs and tax allowable depreciation.
For free cash flow does this tax allowable depreciation not have to be added back after tax has been calculated.
It seems they didn’t do this in the answer.
Thanks in advance,
Alex
Immediately below the table in the question, it says “the tax allowable depreciation is equal to the amount of investment needed to maintain current operational levels”
So although depreciation should be added back, it would then mean subtracting an outflow of exactly the same amount – that is why it is left out completely.
(This is something that the current examiner almost always has in his questions)
| QUOTEAugust 15, 2017 at 10:57 am
Hi John,
I’m sorry I don’t understand the answer you
gave. The question asks whether the
acquisition was beneficial to Pursuit Co’s
SHAREHOLDERS.
Recall in Nente Co(June 2011), to arrive at
the added Value for the shareholder, the equity
values were used. I.e.
Equity value of Combined Coy-(Equity value of
acquirer+Equity Value of Target+ acquisition
premium )=Value added
But now in Pursuit Co, the total MV(debt
inclusive) was used to calculate the value
added from acquisition of Fodder.
If the total value of the firm increases (due to the synergy benefit) then that increase (less obviously the premium paid) must always belong to the shareholders.
You cannot compare it to the question Nente because in Nente there was the additional benefit of an increase in the applicable PE ratio and therefore we had to look at the equity separately.
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