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Dear Tutor,
Please could you explain why in BPP kit question 52 Intergrand synergies from buying the target company are discounted in this question by the cost of equity of target and with assumed growth to perpetuity and why it is not discounted by cost of capital of Intergrand same way as the publicity savings are discounted?
Thank you
Synergy is because of acquisition of Oberberg, therefore to use DF for Oberberg. The question is using APV method for M&A, therefore to use Keu.
Publicity savings is for Intergrand name, therefore to use WACC for Intergand.To dazhong0703 – publicity savings is also due to aquisition of Oberberg.
In other questions synergies are not discounted by the discount rate of the target.
Question states very clearly publicity is for Intergrand name. Just rememever APV method is for different DF. Specifically to use which DF, need your own judgement. Pls do not ask me further regarding this.
Dazhong,
I´m not asking anything to you, so don´t understand your reaction. I´m asking the tutor. It´s “Ask the tutor” forum.
Besides, my question was not about APV method and publicity discount rate.There is nothing wrong by answering you. Because this is a forum, not email. If I am wrong or insufficient, the tutor may correct me.
Dazhong0703 – Please do not answer questions on this forum. The ‘Ask the Tutor’ forums are for people to ask questions of tutors!
Jewel – the reason that the target company is discounted at the cost of equity for the target is that this is the discount rate appropriate for the level of risk in the target. (The risk of Intergrand, and therefore the cost of equity for Intergrand, will be different).
However the publicity savings relate to Intergrand and so they are discounted at the rate appropriate for the risk of Intergrand.
With regard to the growth to perpetuity, that is simply because the questions says in note (k) that the growth is 2% p.a., and later that it should be valued to infinity.
John, thank you very much.
My doubt was because in the question it says that synergies are expected to yield 2MM EUR per annum from 20X4 onwards, so I assumed that after 20X6 it also would be 2MM and not increasing. In the answer given I can see that this 2MM is not increased in 20X5 and 20X6, but since the synergy is incorporated into the free cash flow of target, and it says that after 20X6 the whole cash flow would grow 2%, we increase this element as well.
So I guess all is a matter of stating clearly the assumption.You are welcome.
And yes, you will almost certainly need to make assumptions and as long as you state them (and they are reasonable!) then you will get the marks.
Dear Mr Moffat
With regards to the tax shield calculations, question Intergrand – BPP revision book, the answer includes 2 parts, one is related to the tax shield from the the bonds, the other is the bank loans. However, there was no discount factor taking into the calculation of the tax shield of the bank loan. It just simply takes the principal multiply with the tax rate.
Why doesnt it discount the tax shield on the bank loans?
Many thanks & best regards.
Hanh
Dear Mr Moffat,
Also, the current share price of the Oberberg is 300 Euro whilst it is offering the cash price for 115 million Euro which is 766.7 Euro per share, which is double the current price the market perceives it.
Would you please advise if it would be possible the case in practice and is there any range of the share price, in practice, on how much the offer price should be?
Thanks,
Hanh
First question:
They have taken the tax shield on the bank loans. There is no choice but to assume that the loan continues in perpetuity and therefore if you calculate the tax shield on the interest charge and discount it at the interest rate, you will come to exactly the same figure.
To explain what I mean, suppose the loan was 100, the interest rate was 5% and the tax rate was 30%.
The interest would be 5 per year, so the tax saving would be 30% x 5 = 1.5.
Discounting this at 5% in perpetuity gives 1.5 / 0.05 = 30.
This is the same as simply taking the loan of 100 x 30% = 30.(This only works for bank loans in perpetuity 🙂 )
Second question:
A few things.
Firstly Intergrand is not offering 115M, that is what Oberberg is wanting, and obviously to start negotiations they will ask for as much as possible.
The question is asking whether or not it is worth paying that much which is why we have to value the benefit of acquiring Oberberg.Secondly, in a perfect world, the current share price of Oberberg will reflect the true value of the business. However, the reason Intergrand is prepared to pay more is because of the synergy benefits. This is realistic in practice (even though the excess over the current share price does seem unusually high).
Dear Moffat
Thanks a lot Mr Moffat.
Re the bank loan and tax shield: I could not be able to think that we have to assume that it will continue to infinity. Great!
Re the share price, it is interesting to know further from your explanation.
Many thanks.
Hanh
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