Blah blah blah Co A proposed merger w/ Retardat… Retardat currently has a debt ratio of 20% and a stock beta of 1.1. After the merger the debt ratio will increase to 30% and the stock beta will rise to 1.2. The tax rate is 40%, the return on debt is 10%, the risk-free rate is 6%, and the market risk premium is 7%. Question: What is the appropriate rate to use in discounting the future cash flows of Retardat in order to obtain its merging value? a) 13.70% b) 12.16% c) 14.40% d) 11.88%
I got D using the new beta and debt ratio. That right or am i WACC?
ditto, I went D too… but they said we’re both WACC. Did I forget that the appropriate discount rate is the cost of equity and not the wacc?
is that it or do you use the old ratios b/c you’re looking at the co. pre not post merger? Answer B is the old rates (20% debt, 1.1 beta). Is that the answer? I guess if you told me yes, i’d be ok with thinking sure, you’d value the co. pre not post merger. I would think you’d do WACC not just equity, no? is this a qbank q? this should be pretty easy… i’m WACC.
This was from Allen Resources: Q of the day. >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> Correct answer: C) 14.40% Rationale: The rate used to discount Retardat’s cash flow is Retardat’s return on equity, taking into account the beta after the merger. Re = Rf + β × Risk premium = 6 + 1.2 × 7 = 14.4%. >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> I recall reading that you use post merger #'s since you are valuing the co’s value as a merger candidate. But I could not remember anything about using the cost of equity instead of the wacc to discount the cash flows. Anyone know why off the top of their head?
i’ll check back on my notes tonight- i just finished this section (schweser) and i don’t off the top of my head remember it saying anything about using cost of equity vs. WACC. figures the answer is the easiest one to calculate after we both took it the next step. do you use allenresources? can you email them back and ask them why? not sure as a service provider how much info they’d give you or how receptive they are to questions. I’d definitely be interested in the “why” here if you get a reply.
I don’t subscribe to allen res. but I do their free online q of the day. I like to sit for a minute or two each morning with a cup of coffee at my desk and frustrate myself. Frequently they throw one of these q’s out that get me scratching my head and it bothers me all day. Then when I get home I pull out my books and realize I am just wrong.
Guys, I think we should be using WACC on this one, although the answer suggests otherwise. Exhibit 3 on pg 276 of Book 3 is discounting the FCF using WACC. The book states that FCF as is used there is cash available to the firm after making all necessary investments to keep the co’ in business. I think this problem would have had to state that the CF were for equity holders for us to use CAPM. Can you clarify if you found otherwise? Thanks.