The limitations of the estimates stem from the fact that although the model used is theoretically sound, it is difficult to apply it in practice for the following reasons.
The calculations in part (i) are based on a number of assumptions such as the growth rate in the next four years, the perpetual growth rate after the four years, additional investment in assets, stable tax rates, discount rates and profit margins, assumption that debt is risk free when computing the asset beta. All these assumptions would be subject to varying margins of error.
It may be difficult for Pursuit Co to assess the variables of the combined company to any degree of accuracy, and therefore the synergy benefits may be hard to predict.
No information is provided about the pre-acquisition and post-acquisition costs.
Although it may be possible to estimate the equity beta of Pursuit Co, being a listed company, to a high level of accuracy, estimating Fodder Co’s equity beta may be more problematic, because it is a private company.
Given the above, it is probably more accurate to present a range of possible values for the combined company depending on different scenarios and the likelihood of their occurrence, before a decision is made. |
