---------Mergers and Acquisitions---------
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Question (a)
What is the estimated value of Murdoch Inc? What are the possible biases due to the valuation method? What other methods could you have used?
1. We use discounted cash flow method to valuate Murdoch Inc which is not a listed company. Discounted cash flow method is probably the most important determinant of a valuation and it uses the definition “The value of a company is equal to the sum of the discounted values of all future cash flows.” Discounted cash flow method is based on the forecast of company’s free cash flow in the future and determines the value of company discounted by the appropriate discounted rate through the cash flow or net earning in the future.? We can use the formula below to do the valuation:
????????????? ?????(1)
Where:
BV: Value of company
FCFi: The free cash flow at the ith period
r: Discounted rate
The discount period is unlimited duration and we can consider r in the formula (1) as WACC (Weighted average cost of capital). WACC means the average rate paying on the specific mix of debt and equity which is given by this formula below:
????????????? ?????(2)
Where:
Re means the cost of equity.
Rd means the cost of debt.
E = market value of equity
D = market value of debt
t = corporate tax rate
We can use CAPM (Capital Asset Pricing Model) to estimate the cost of equity capital.
?? ?????????????????????(3)
Where:
Rf means the cost of risk-free capital and it can be understood to the risk free rate today.
Rm means the return on the weighted average of all investments in the market.
Rm –Rf means the average extra return on shares, over and above the risk-free rate and can be considered as Market Risk Premium.
?measures the specific risk of one company and its closely related to the gearing.
Companies in the same industry, of the same size, and identically geared, should have approximately similar beta if companies are ungeared. The assignment doesn’t provide us the beta of Murdoch but give us the beta and other useful financial information of Mclntosh plc which is a listed firm in a similar business. We can estimate β of unlisted Murdoch by using the beta of Mclntosh. Table 1.1 below shows the information about Mclntosh plc.
Table 1.1 Financial data of Mclntosh plc
Mclntosh plc |
Current risk free debt |
￡80mn |
Beta of equity |
1.2 |
No. of shares |
30mn |
Market price of stock |
￡25 per share |
Corporate Tax Rate |
35% |
Risk Free Rate |
8% |
Market Risk Premium |
8% |
First of all, we can calculate the ungeared beta of Mclntosh using the formula below:
???????????????????? (4)
Where:
ug = d beta
E = market value of equity
D = market value of debt
t = corporate tax raungeared beta
g = gearete
E (Mclntosh) = No. of shares * Market price of stock = ￡30mn*￡25 per share = ￡750mn
Thus, 
=1.122
We can assume the ungeared beta of Murdoch is 1.122 and then we can get the geared beta of Murdoch using the formula (4). Table 1.2 shows the financial data about Murdoch Inc.
Table 1.2 Financial data of Murdoch Inc
Murdoch Inc |
Current debt |
￡500mn |
Annual interest of current debt |
-￡50mn |
Projected net income (after interest and taxes) |
￡200mn |
Restructure |
-￡50mn |
All cash flow growth (g) |
2% per year |
No. of shares |
25mn (privately owned) |
Debt/Equity ratio |
0.4 |
E (Murdoch) = Debt / Debt-Equity ratio = ￡500mn / 0.4 = ￡1250mn
=
?= 1.414
Now we find the geared beta of Murdoch is 1.414 and can calculate the Re of Murdoch using the CAPM formula (3),
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