hard · Principles of Finance valuation
A target firm will be acquired and its capital structure changed: the deal raises permanent debt to a new fixed dollar amount, then leverage is allowed to drift as the firm grows. The acquirer's analyst must choose a valuation method.
Which approach is the MOST appropriate, and why is a constant-WACC valuation specifically problematic here?
- Use APV: discount unlevered FCF at the unlevered cost of capital and add the tax shield discounted at the cost of debt, because the debt level — not the ratio — is fixed initially.
- Use constant WACC: the post-deal target ratio implied at closing pins the cost of capital for all future years regardless of how leverage subsequently evolves.
- Use the flow-to-equity method exclusively, because only equity cash flows are observable after a leveraged acquisition and WACC cannot be defined.
- Use a constant WACC built from the industry-average leverage, since deal-specific leverage is transient and reverts to the industry norm.
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