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Hi John,
Is it that market value of a company is the value of its Equity only, or are we sometimes concerned also with any debt it may have?
Most questions I had practiced were concerned with equity only, then in Q Pursuit June 11, the Synergy is calculated as :
Total value of combined firm (being its FCFF i.e. Debt + Equity)
less
value of the individual companies pre-acquisition (again taking values for each as Debt + Equity)Why is this?
The question talks about Pursuits “total firm value” (MV of Debt + Equity), is this why the answer includes Debt as well in the calculations above?
Would it have been wrong to deduct the debt values from the synergy formula above, and focus on equity values only, as most other questions seem to do?
Thanks
The total value of the company (got by discount the free cash flows at the WACC) is the value of the equity plus debt.
Any gain in the total value belongs to the shareholders.A change in the market value of debt obviously affects the debt lenders.
However a gain in the market value of a company due to synergy effects the equity because they own the company and extra profits belong to the shareholders not the debt (the debt lenders get fixed interest).
Thanks John.
And one related q that confuses me – is it only a good thing for a company if the market value of its debt goes down (eg if it has a corporate bond in issue say 5% coupon, and then later the required return goes up on the market to say 7%, causing the current bonds to go down in value ). This reduces the market value of a company’s liability (but not its book value per SOFP) so it must be a good thing? Or can it have any adverse effect, in say the way a drop of a share price can cause shareholders to sell their shares and further price drops (which is bad for the reputation of a company). Is there anything similarly bad about the drop in the market value of debt (from perspective of the issuer)?
The main factor that affects the MV of debt is changes in general rates of interest, and that does not reflect on the company.
If debt investors think that there is more risk of them not receiving the interest or the repayment, then this would make them require a higher return which would reduce the market value – but this would happen because the company was seen as being risky rather than the other way round 🙂
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