Which of the following is true regarding takeover valuation? I. The bidding firm

Question

Which of the following is true regarding takeover valuation?

I. The bidding firm should always use its own cost of capital for status quo valuation of the target firm
II. It is important to avoid attributing the debt capacity of the bidder firm to the target firm when valuing the status quo value of the target firm
III. Nominal cash flows should be discounted at nominal rates, not at real rates, so as to avoid incorrectly valuing the target firm's cash flows

Select one:

A. I only

B. I and II only

C. I and III only

D. II and III only

E. I, II, and III

F. None of the above

Which of the following statements is true concerning management buyouts?

I. Due to the potential for synergy, buyouts are usually more complicated to value than mergers
II. Asymmetric information may allow managers to make a more accurate estimate of the target firm's value
III. The target firm is rarely taken private after the buyout occurs

Select one:

A. I only

B. II only

C. I and II only

D. I and III only

E. II and III only

F. I, II, and III

Explanation / Answer

(A) The bidder firm's risk level, both business and financial would be absolutely different from the target company's risks, thereby requiring a cost of capital relevant to the target firm's risk level and not the bidder firm's risk level.

It is important to avoid attributing the bidder's debt capacity to the target while valuing the latter as the latter might already be leveraged to a different extent as compared to the bidder, thereby making any comparison between the two firm's debt capacity incorrect.

The nominal cash flows are always discounted at the nominal discount rate and same for real cash flows and real discount rates. Mixing up the two is incorrect and will lead to an erroneous determination of cash flow present values.

Hence, statement II and III are correct and the correct option is (D).

NOTE: Please raise a separate query for the solution to the second unrelated question.

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