Hi Guys,
Is there a discount rate applied with an acquisition being financed with a 100% cash and using the Discounted Cash Flow model?
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Yes. You're not discounting the cash you're paying with, you're discounting the expected future cash flows of the business you're buying.
so I guess it was a trick question. I was asked what discount rate to use in a dcf model if the company is financing the purchase will all cash
What was your answer?
As above, discount rate doesn't depend on how you're financing the transaction - two different things. Think of it this way: 1) find value/price of target (using an appropriate discount rate in the DCF) and then 2) how are you going to finance the purchase?
I believe I answered it incorrectly because I didn't understand the question initially, so I stated WACC, but cash is not apart of that equation. So I stated using median comps for WACC as a barometer of the discount rate that should be used. The target company would be a relatively small all cash deal.
Doesn't it though? Financing with debt adds value because of the debt tax shield.
Valuing a company using DCF, the "appropriate" discount does depend on the financing. For an all equity transaction, you'd use return on assets as the DR. For a debt and equity transaction, you'd use WACC or APV.
In a typical example, the process looks something like this: 1. Find companies similar to the one you're looking to buy 2. Calculate their equity betas 3. Unlever said equity betas using each companies D/E to find asset betas 4. Average asset betas 5. Re-lever the average asset beta using D/E for the acquisition to find it's equity beta (skip this step if all-cash) 6. Calculate required return on equity using Re = Rf + Be (Rm-Rf), where Rf is the risk free rate and Rm is the market risk premium 7. Calculate WACC and use it to discount future cash flows
Without taxes, use the Ba calculated in Step 4 to calculate Ra and then discount.
Are you talking about the valuation of a target company? If yes, discount rate to be applied is not dependent on the terms of payment of the transaction. Discount rate is based on the factors such as industry of the company, uncertainty of the forecast, and other risks.
Yes it was for a valuation model for a target company
Damnit, I came on here for a 5 minute break from studying for my finance final tomorrow and this is what I see. Guess I'll get back to it...
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