Our technical board member says that the finance decision (100% equity or debt financing) of a 100% equity owned target firm has an impact on the value of the target. This is wrong isn't it?

Question

Our technical board member says that the finance decision (100% equity or debt financing) of a 100% equity owned  target firm has an impact on the value of the target. This is wrong isn't it?

anonymous · Answer

Can the target afford to carry the debt on its own? If so, you are exploiting the fact that the firm is under levered to increase its value by using a debt ratio more appropriate to the firm (than using 0%)

kiki · Answer

Sorry, maybe my question was misleading. I mean is it a difference if you buy a target, which has no debt in the BS,  either with 100% equity or with 100% debt? Does the value of a target depend on the financing dicision of the buyer?

anonymous · Answer

if debt is used, you can deduct interest paid therefore requiring lower cost than equity. Lower cost means lower cost of capital, therefore, lower discount rate which results in higher value of the target firm. I think.

anonymous · Answer

cost of debt is normally lower than cost of equity, so... wacc would be higher then. under the wacc model (Modigliani-Miller), i don't think the financing option affects the value of the target, but of course it all depends on what the purchaser is planning to do. Merge? Acquire as a separate subsidiary? or the target firm has a valuable asset? 

still, it is quite unlikely for a firm not to have any debt, in imo, as it would mean that the asset = equity. wow, what a buy! any idea what industry or kinda firm it might be? have not come across this before.