In computing the share price for a M&A target, which of the following statements is not...

In computing the share price for a M&A target, which of the following statements is not true?

Group of answer choices

Financial risk is incorporated in the cost of equity in the form of a levered beta.

Interest is implicitly recognized because we are buying the equity.

The acquiring firm’s tax rate is used to compute the cashflows.

Next year’s dividend is used to compute the residual value.

If the computed share price is greater than the current price, an offer should be made.

Solutions

Expert Solution

In computing the share price for a M&A target, which of the following statements is not true?

Option1: Financial risk is incorporated in the cost of equity in the form of a levered beta.

Explanation: Cost of equity calculation uses unlevered beta. This statement is false. (CORRECT OPTION)

Option2: Interest is implicitly recognized because we are buying the equity.

Explanation: By creation a synthetic equity, returns are in in the form of interest and not dividends. So, this statement is correct. (INCORRECT OPTION)

Option 3: The acquiring firm’s tax rate is used to compute the cashflows.

Explanation: This is a correct statement. (INCORRECT OPTION)

Option 4:Next year’s dividend is used to compute the residual value.

Explanation: Future dividends are used to compute the value just like residual income calculation. (INCORRECT OPTION)

Option 5: If the computed share price is greater than the current price, an offer should be made.

Explanation: When computed share price is higher than current price, the stock is undervalued. So, an offer should be made. Statement is correct. (INCORRECT OPTION)

jeff jeffy answered 1 year ago

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