Question

Mergers and Acquisitions and WACC

A. Levered vs. unlevered beta. What is the difference and when/how are they used?

B. What is APV? How is it used? How does it differ from WACC?

C. How do you calculate APV.

D. What is WACC? Why is it important? How is risk adjusted?

Answer 1

A.) Levered beta which is also known as beta or equity beta is a measure of market risk. Debt and equity are factored in while assessing a company's risk profile. It measures the level of systematic risk. Systematic risk is the risk that cannot be diversified away. Examples of systematic risk include natural disasters, political events, inflation and wars. Beta is a statistical measure that compares the volatility of the price of a stock against the volatility of the broader market. A beta of two means the company is twice as volatile as the overall market, but a beta of less than one means the company is less volatile and presents less risk than the broader market.

Unlevered beta strips off the debt component to isolate the risk due solely to company assets. The level of debt that a company has can affect its performance, making it more sensitive to the changes in its stock price. Unlevered beta treats it like it has no debt by stripping off any debt of the calculation. Since companies have different capital structures and levels of debt, to effectively compare them against each other or against the market, an analyst can calculate the un-levered beta.

B.) APV is used for valuation of projects and companies and it takes NPV plus the present value of debt financing costs which include interest tax shields, financial subsidies, cost of debt issuance etc. The APV takes into consideration the benefits of taking debts. APV analysis can be preferred in highly leveraged transactions.

It is different from WACC in the sense that the APV method uses unlevered cost of capital to discount free cash flows., as it initially assumes that the project is fully financed by equity.

C.) Steps to calculate APV

First, we have to calculate the value of unlevered firm

Second, Calculate the net value of debt financing.

Third, Sum up the value of the unlevered project and the net value of debt financing to find the APV.

D.)

WACC represents the blended cost of capital across all sources, common stock, debt, preferred stock etc. The cost is capital is weighted by its percentage of total capital and they are added together.

WACC is used as an important tool by investors to determine whether to invest in a company or not. It is a well-accepted financial tool by companies and analysts.

It is risk-adjusted by adding the extra risk premium into the existing WACC.