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Business Sample Questions: Forecast, Weighted Averages

Question 1)
Why WACC cannot be used as a discount for calculating the value of a merger and acquisition for the first few years of the analysis?

Question 2)
When calculating the value of a target for acquisition, why do different acquirers arrive at different valuations for the target?

Question 3)
Calculate the cost of unlevered equity if the cost of equity is 20%, the cost of debt is 7%, and the capital is 50% equity and 50% debt.

Question 4)
Calculate the cost of funds or WACC if the cost of equity is 20%, the cost of debt is 7%, and the capital is 50% equity and 50% debt. The tax rate is 40%.

Use the following information for Questions 5 through 8

Suppose we are planning to buy a company with the following forecasts:

The cost of debt is 5%
The cost of equity is 20%
The tax rate is 40%
The company has 15 million shares outstanding
The current stock price is $2.05
The company is currently holding no financial assets.
The company has $3,000,000 in debt.
WACC, the cost of capital, is equal to 11.5%
RSU, the cost of unlevered equity, is equal to 12.5%

Question 5)
Calculate the value of the debt tax shield.

Question 6)
Calculate the horizon value of the target.

Question 7)
Calculate the value of operations.

Question 8)
What is the highest offer price we can make? Is the acquisition feasible?

Question 9)
Why do the target's free cash flows vary from one acquirer to another?

Question 10)
What are the main disadvantages of the payback method for evaluating projects?

Table is in attached document.

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Solution Preview

Question 1
WACC or weighted average cost of capital is the required rate of return for capital projects or projects that last for more than a year that are of 'average' risks and a merger and acquisition project is clearly not a average type of a project. Hence a different required rate of return, which incorporates the higher than average risks faced by a merger and an acquisition, should be used to calculate the value.

Question 2
Different acquirers arrive at different ...

Solution Summary

Sample business questions