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Hi John,
In Example 3 of Chapter 16 of your notes, when acquiring an org of a different business risk, you suggest using the business risk of the target company and regearing this @ acquiring org’s D/E to form basis of a suitable cost of equity, and from this WACC, to discount the FCFs of the target.
In the BPP textbook, for a similar scenario, they get the asset beta for both firms and calculate a “post-acquisition asset beta” for the new combined firm, on a basis of proportion values of Debt+Eq contributed by each firm (a basis they note is not strictly accurate as this doesn’t accurately value the combined firm).
I guess their approach seeks an “average asset beta”, as to assume the new combined org will hold only the business risk of the target after acquisition seems unlikely (is this the approach your example takes?)? In the spirit of company valuations being “an art not a science” is this an area doing either approach and stating the assumption/limitation is fine? Many thanksI think you are probably misinterpreting the BPP Study Text.
In my example that you refer to, the question specifically asks for the discount rate to be applied to the free cash flows of B in order to arrive at a value for B plc, and what I do in the lecture working through this example is completely correct.
If instead we were being asked to value the ‘enlarged’ company, then we would indeed use the average beta, as I explain in my lectures on CAPM.
(I assume that you are not using the notes on their own – they are lecture notes (and not a Study Text) to be used while watching the lectures. It is in the lectures that I explain and expand on the notes 🙂 )
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