Question

I'm having discussions here about which is the right discount rate to use when valuing a potential target. Should we use our own WACC? Or should we calculate the wacc of the target (taking into account its cost of capital and the risks associated with its cash flows)? Or should we use an "arbitrary" discount rate? (let's say our shareholders demand at least 20% of return so we use this as our discount rate)

Answer 1

Well you should calculate WACC using debt/capital ratio that reflects the desired leverage that the acquirer intends to maintain on the target's balance sheet post acquisition. In addition to this please make sure that the the target's business risk and financial risk is reflected in the cost of equity and cost of debt. Hope this helps.