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Hi sir,
I got some questions regarding Type 3 Acquistion. for this type of acquisition, i understand that we have to use iterative procedure, which we need to follow the steps below:
1) Degear the equity beta of the bidding and target company respectively.
2) Find the weighted average of the asset beta, or in other terms, the combined asset beta.
3) Regear the combined asset beta to reflect the post-acquistion gearing position
4) Plug the Combined Equity beta into CAPM formula
5) Combined WACC is then calculatedSo my problem arises in Step 2 and 3 regarding the Market Value of equity and debt.
For step 2, should we use both the market value of (equity and debt) for weighting purpose? or we only use the market value of (equity)? in other words, should we actually exclude the market value of debt?
For step 3, we will certainly use both market value of (equity and debt) for re-gearing purpose. But whose Market Value should be used?
i) the bidder itself, or
ii) sum of the market value of both bidder and target companyI hope to hear from you soon. thank you.
Best regards,
Esther PangA brilliant question 🙂
For step 2, strictly you should use the ungeared market value (I mean the market value if it they were both all equity financed). For the exam you should simply use the total market value (debt + equity).
For step 3, you should use the gearing of the ‘enlarged’ company. If that is not given then use the gearing of the bidder company (but do state your assumptions – the assumption here would be that the ‘enlarged’ company had the same gearing as the bidding company.
Sir, if i use only equity as weightage to calculate the combined asset beta would it be acceptable? Because i thought asset beta is only affected by equity. Thank you in advance 🙂
The asset beta is not affected by the gearing – it measures the risk of the business having removed the risk due to the gearing.
It should be weighted by the total amount invested in each stream.
Since asset beta excludes the effect of gearing then shouldn’t it be weighted by only equity? (When both co is debt+equity financed)
I am slightly confused here because in bpp textbook one example used only equity (1,100 and 156) as weightage to calculate combined asset beta. The acquirer has 50mil shares with current mkt value of $22 each and debt $60mil; the acquiree has 65mil shares with a total current mkt value of $156 mil and debt $12.5mil to be taken over by the acquirer.
Yes – I know the question you mean, and it is a bit debatable (because the examiner himself is not consistent). Sometimes he has used equity and sometimes he has used total.
Obviously in some questions you have no choice on the information given. If you do have a choice then best it simply to state your assumption. Depending on the assumption the answer will be different, but that does not matter in P4 – so often you are forced to make assumptions (and state them) 🙂
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