Question

Triangle Ltd is an ASX listed company which aims to acquire 100% shares of an unlisted firm, Square Ltd, both of which operate in the same industry.

Triangle capital structure comprises of 50% Debt and 50% equity with beta debt of 1.34. To finance acquiring Square, Triangle is facilitated to borrow up to 35% of funds needed with no material effect on its credit rating.

a) If risk free rate is 4.3% and return on market is 9.3%, calculate Triangle cost of equity using CAPM.

b) How much is Triangle WACC if tax rate is 30% and cost of debt is 7.5%?

c) Calculate WACC of Square.

d) Explain in detail what would happen if Triangle evaluated the purchase of Square using WACC of Triangle?

Answer 1

a)

 

b)

 

c)

 

d)

as the capital structure of the Square is less risky than the cost of capital of the triangle, so if we evaluate the purchase of the square using the WACC of the Triangle, the valuation of the square will be lower than the fair valuation.