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Dear Sir,
I am under the impression that when carrying out valuations we are interested in the value of equity-whether using free cash flows or the market values of shares.
Is this not the case?
I am asking because in the above question part (a), the total market values of pursuit, Fodder and the combined company have been used in finding the additional value created out of the acquisition. Why is that so?
I subtracted the proportion of debt (using the capital structures) away from the values I got for their total market values. Apparently this is wrong per the answer,and this left me confused.Kind Regards
Sam
Using free cash flows gives the value of the business as a whole (i.e. equity + debt).
Using free cash flows to equity gives the value of the equity alone.If there was no tax, then (per M&M) the value of the business as a whole would be the same regardless of how it were financed (all equity, or equity plus debt). With tax, certainly the value of the firm as a whole will increase if there is more gearing, but this ‘benefit’ comes from the choice of gearing – not because the firm as a whole is earning more.
Thank you for your time.
My concern is this:
In part a(i)
we want the net benefit to pursuit and its shareholders-we are asked to use the free cash flow to firm method.what comes to mind immediately is to find the total value (equity+debt) of each company using the free cash flow to firm method. we do same for the combined company.
Now, because we are interested in the benefit to shareholders, we extract the equity values from the total market values calculated above, and we go ahead to find the net benefit for shareholders by doing the following:
1. equity value of combined – (equity of pursuit + equity of fodder)
The answer follows this process but used total market values (debt +equity) in formula 1 above.
This is my worry. Why is that?
Kind regards
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