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Alternatively - Cash flows greater by the ITS Hence, value greater by PV(ITS)
VL = VU + PV(ITS)
PV of ITS?
When perpetual fixed debt:
PV(ITS) = T x D (discount rate is RD)
Cost of capital
Capital allocation:
Asset beta from peer group equity betas through unlevering Equity beta of divisions from the asset beta (say, average) through re-levering (at target D/V)
Cost of capital
Debt holders share the risk of the asset with equity holders
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Stock acquisition:
Gain to target = (VA x t VT x a) + S x t Gain to acquirer = (VT x a VA x t) + S x a
On merger announcement:
PT = PA x Exchange Ratio
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Target valuation
Strategic acquisition:
WACC for discounting targets cash flows = Targets WACC (no financing impact)
LBO:
Financing impact (high PV (ITS)) possible through greater leverage
Greater D/V ratio on acquisition
Financing equity/convertibles
Large equity issues require price discovery bookbuilding & stabilization very common Convertibles address some of the market frictions
Information asymmetry
Agency cost
Risk Management
Concern about risk from non-core elements of business
Horizon for hedging through derivatives usually 1-2 years Approach to risk measurement, and management:
Net exposure to cash flows/profit (natural hedges accounted) Risk = Exposure x Volatility for the horizon
Large risk => risk management policy Small risk => view
Risks over longer horizons managed with operational or strategic decisions Risk management directly relevant for non-equity claimants (creditors, employees)
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Beta lower if investors portfolio less than perfectly correlated with the proposed asset Other sources risk country specific risks -- sovereign risk
These suggest that real cost of capital could vary across investors
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