Which of the following best describes the appropriate approach to estimate the WACC for a private company acquisition? The WACC should be :
A. Target WACC
B the acquirer’s WACC
C. A weighted average of the target’s and acquirer’s WACC that factors in financing arrangements
the answer given is A
Should it not be B the acqirer’s WACC, since after acquition the required return on equity would be that of acquirer( their(acquirer and target) shares do not sell separately right? so, absent a minute adjustment to the acquirers risk estimates because of the acquisition, equity buyers would demand what they demanded for the acquier in the first place) and debt providers too will ask return commensurate with the acquirer only.
No, it should be A, the reasoning for that is that the usage of the acquirers WACC transfer value from the buyer to the target company…
An example: If the target is a small risky company, then it would have a higher WACC than the acquirer, then the company value will be lower… If you use the acquirers WACC you’re paying more for the company! remember your are valuing a company prior acquisition… after that things change.
Thanxx for the explanation jorge. however, i still have doubts
The valuation is indeed done prior acquisition, but as you said after that things change.
So i being the acquirer(a large public firm) would want to see what that company is worth to me after the acquisition. Small risky company wont have financing problems after i have acquired it. and other risks too will mitigate to my level only as i can change the management to the most efficient one i can provide. So if a company is there which has a higher WACC, meaning low present value, would be worth more to me after acquition as i can reduce the risk substantially and approximately bring it down to my level. Hence my WACC should be used.
I think first of all is a Business transaction, and you, as the buyer company, would like to pay the fair value of the company, so you would like to pay less.
As I understand, the curriculum is very specific regarding this issue, and they say you should evaluate this type of transactions using the target company so you dont transfer value from the acquirer to the target.
All the things you mentioned, will eventually improve the value of that company (because indeed you will improve its WACC) after you acquire that company and hence you will improve the value of your company (thats why you are acquiring), but the price paid for the acquisition should be determined with the targets WACC.
However thats how I understand this part of the material, hope my comments can help
The idea here is that once you have control of the company and therefore control of its capital structure, you will adjust it such that you acheive the target capital structure and target WACC. So, the target WACC is the most appropriate to use.
If targets WACC is most appropriate because it is most reflective of the existing business risk and operating environment of the company then why do we add synergy effect in strategic transactions?
I mean synergies are going to be present after the acquisition. and if we add the effect of synergies we should add the effect of other post acquisition changes too like, more efficient management, easy availability of capital etc.
synergies are added because they show what the busines will be worth to the acquirer after it has been acquired. So any inefficiencies that the acquirer can mitigate should be taken into consideration while valuing the business for the acquirer.
I am just a little confused here. anybody with a little explanation
Because the synergies don’t affect the value of the target company itself, rather, the synergies would affect the value of the merger when analyzing the business combination post-merger.
Synergies would be relevant to evalatuing a bid because one would expect to pay a premium to the value of the company to induce the owners of the company to give up control.
For example, let’s say i want to buy company X. I think company X is worth $10 on a standalone basis. I think if i own company X, it will add $5 in synergies to my business. Therefore, the most I would be willing to pay for company X would be $15 (even though i think the company itself is only worth $10).
Exactly my point. I think company X is worth $10 on standalone basis and one contributing factor to that valuation is high discount rate that i used because the company doesn’t have access to capital that easily whereas when it merges with me i can get it easy and cheap capital funding so the discount rate would decrease hence i would pay more for that business.
Sure, but in that case you would in effect be paying the acquired company for value you bring to the table by discounting at your own WACC, as opposed to establishing value based on the riskiness of the target’s cash flows.
