# During business combinations very often the wacc must

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During business combinations very often the WACC must be recalculated on a continuous basis due to the fact that the capital structure may be adjusted repeatedly. - In order to simplify this process – there are two adjusted versions of FCF Free Cash Flow to Equity - This is the first adjusted version of FCF - Reflects the cash available to only the ordinary share holders of the company 9 | P a g e Given the above information it is possible to calculate the WACC for after the combination. Step 1 : calculate unlevered beta value B U = _ 1.5 _ = 1.19 [ 1 + ( 0.70 ) 450 000 / 1 200 000 ] Step 2 : calculate the levered beta value B L = 1.19 x [ 1 + ( 0.70) 50 / 50 ] = 2.02 Step 3 : calculate the cost of ordinary share capital after business combination K OS = R f + ẞ ( R M - R f ) = 8% + 2.02 ( 15% - 8% ) = 22.14% Step 4 : calculate the WACC for after the business combination WACC = 0.35 (22.14%) + 0.15 (3.75%) + 0.25 (7%) (0.70) + 0.25 (11%) (0.07) = 11.46% FCFE = FCF – INT + ΔD INT = the after-tax interest expense (calculated as interest x (1-T)) ΔD = the net change in debt capital per year

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The interest rate on its debt capital is 10%, and it expected that additional debt capital to the value of R10 000 per year will be requir - The FCF’s are discounted at the firms cost of equity - The FCFE estimations are made for a specific forecast period - Followed by calculation of the terminal value to reflect the perpetual increase in the FCFE values beyond the forecast period - Often thought to be easier since the calculation of WACC is not necessary - NB to remember that FCFE has been developed based on the assumption that the target company’s capital structure isn’t adjusted after the transaction. - If there is adjustments during the combination then the value of equity must be recalculated the reflect the influence on the adjusted degree of financial leverage 10 | P a g e
Capital Cash Flow - Reflecting the interest expense associated with the use of debt capital in the cash flow calculation - The tax benefit is therefore included in the company’s FCF and then discounted at unlevered cost of equity - In order to calculate the unlevered cost of equity, use the following equation: 11 | P a g e CCF = FCF + Interest Tax Shield Interest Shield = Interest x T K e, U = w e k e,L + w d k d W e / W d = weighting of equity and debt in capital structure k e,L = the levered cost of equity k d = cost of debt capital Example (page 127) Let’s reconsider the previous example. Abstel is a mature company, and no competitive benefits are expected from the acquisition. Abstel’s current FCF is R200 000 and is expected to perpetually increase by 2% per year. The company currently has total assets to the value of R1 000 000, and its target debt-total assets ratio amounts to 40%. The interest rate on its debt capital is 10%, and it expected that additional debt capital to the value of R10 000 per year will be required to finance the growth in turnover. Abstel’s cost of equity is equal to 18%, while the marginal tax rate amounts to 30%.

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