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Hi Mr John,
I have a question regarding the free cash-flow method of valuation.
When we are calculating the percentage gain for both sets of shareholders under a share for share offer, we have to get the combined company value first and then get the the number of shares in the combined company to arrive at the MV of the one share of the combined company.
The value of the combined company is calculated in two different ways sometimes and I am suspecting the reason but I want to confirm it.
1. Sometimes, the combined company value is calculated as (PAT of the predator + PAT of the victim + Synergies) – Then we calculate the EPS of the combined company and calculate the MV by multiplying the PE ratio of the predator to the EPS.
2. Other times, the combined value is calculated through getting the equity value of the victim company (MV of share * Number of shares) + equity value of predator + Synergies, then this is divided by the number of shares of the combined company to arrive at the share price of the combined company.
When do we adopt the first method and when do we adopt the second?
I am guessing the first one is adopted when the predator’s PE is higher than the victim’s? and when we are told that the PE ratio will be maintained by the combined company (and this is called bootstrapping).
..and the second is adopted when the reverse happens, and that’s is, the victim’s PE is higher than the predator’s, both has different PE and we are not told what the combined company PE is?
Kindly confirm.
I also have a question as regards Macauley Duration – This comes in two contexts, in bonds and investment appraisal.
Is the calculation method the same for both contexts? That is getting the PV for all positive cash flows. Then multiplying each positive PV by its time period. Then dividing the total of the second by the total of the first.
Because when I solve it this way in project appraisal, i get a slightly different answer from the one in BPP and they are solving it in a weird way (well BPP always complicated things, I notice!)
Anyways, hope my questions are clear.
Many thanks and please wish us luck.
Maha
With regard to the takeover, it obviously partly depends on the information available.
If the information is available to do it both ways, then your logic is valid. However, there is rarely just one ‘correct answer’ in P4. Provided you have given a reasoning for your approach (and your reasoning is fine) then you will get the marks.With regard to the Macauley duration – yes it is the same working whether it is bonds or investment appraisal. I cannot really comment on what BPP may have done. (If it is only slightly different then I would not really worry anyway 🙂 )
Good luck next week 🙂
Thank you very much for your explanation and thanks for your wishes 🙂 Hopefully the exam will be as expected! 😀
Regards,
Maha
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