Question

Can we use the acquiring firms WACC to value the target firm? If so what would be the reason?

Answer 1

No. Lunacy or laziness.

Answer 2

No. The WACC is calculated for each firm, there is no reason to discount the FCF of a firm with another WACC that may be do not reflect the operation and financial firm of the firm that you are acquiring. Sorry with my english

Answer 3

Even if we cant estimate the target firms WACC? Then what should be used to discount the target firms cash flow.

Answer 4

Tkhan, Why you can't estimate the target firm WACC?

Answer 5

the target firm WACC

Answer 6

Im looking at a case study in which the target firm's WACC is impossible to calculate because we'r not given enough information. So what are the other alternatives?

Answer 7

you can use bottom up beta of similar companies in the industry where the target company is operating for estimating cost of equity and using the same method for cost of debt and use book values of equity and debt of target company if you don't have their market values.

Answer 8

Tkan, you have got a trick question.
If they do not have enough information on the target company, why are they looking to acquire that company?

Answer 9

Another question. Can we take the parent company's WACC to be used for the Subsidiary? And if we dont have market value of equity or debt is it ok to use book values?

Answer 10

Tkahn,

Technically, each subsidiary line of business will have its own WACC. The riskiness of a project is dependent on the project, not the investor or the parent company. Generally, using the book value of debt is appropriate because the book value of debt does not differ materially from the market value (at least under normal circumstances). Using the book value of equity is probably inappropriate as a proxy for the market value of equity, unless the firm is earning a return on equity capital equal to its cost of capital. In this case, the book value of equity will equal the market value of equity (at least theoretically).

Also, I will make the argument that using the parent's company's WACC can be appropriate in certain circumstances, but not all. For example, if the target operates in the same line of business and is therefore subject to the same business risks as the acquirer, I believe that the the acquirers WACC will be an excellent proxy for the target. Really, the only time the acquirers WACC would be inappropriate is if the risk of the target was materially different that that of the acquirer. In those circumstances, the acquirer needs to develop a WACC commensurate with the risk of the target. Using the acquirer's WACC in those circumstances would tend to under/overstate the value of the target, depending upon the differences in risk.

Answer 11

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