Which of the following is correct regarding the most appropriate discount rate to be used in valuing the targeted firm?
A)The appropriate discount rate to be used when calculating the NPV of a target company is the cost of equity of the acquiring firm.
B)The appropriate discount rate to be used when calculating the NPV of a target company is the cost of debt of the target company.
C)The appropriate discount rate to be used when calculating the NPV of a target company is the cost of equity of the target company.
D)The appropriate discount rate to be used when calculating the NPV of a target company is the cost of junk bond debt of the target company.

Question

Quizplus · Accepted Answer

The appropriate discount rate to be used when valuing a target company is the cost of equity of the target company. This is because the cost of equity reflects the risk associated with the target company's operations and the return required by shareholders. The cost of equity is also used to determine the target company's WACC (weighted average cost of capital), which is used to discount future cash flows to present value. The cost of equity of the acquiring company or the target company's debt is not an appropriate discount rate as they do not reflect the risk associated with the target company's operations. Junk bond debt is not an appropriate discount rate as it is an indication of high risk and will result in a higher discount rate, which could overstate the NPV of the target company.

Which of the Following Is Correct Regarding the Most Appropriate