firmstockholders,whoplayednoroleintheacquiringfirm’s
higher rating, be paid a premium for that higher rating?
Payingthishighervaluewouldresultinatransferofwealth
from theacquiring firm’s stockholders to thetarget firm’s
stockholders.
2.Anacquiringfirmwithexcessdebtcapacityusesthisdebt
capacitytofundtheacquisitionofatargetfirm.Thetarget
firmwillbeacquiredwithadisproportionateamountofdebt,
wellinexcessofwhatitcouldhaveusedtofinanceitsown
operations.Ifwevaluethetargetfirmwiththishighdebtratio
(and low cost of capital),we willundoubtedly arrive ata
much higher value. Paying that high value would be a
mistake, though, since wewould be subsidizing thetarget
firmstockholdersforsomethingthattheydidnotcreate—the
acquiring firm’s excess debt capacity.
Ata moregenerallevel, acquiring firmshavebeenalltoo
willingtoconcedethevalueofbothsynergyandcontrolto
targetfirmstockholdersinmergers.Aswenotedearlierinthe
chapter,afairsharingofsynergyshouldleavetheacquiring
firm’s stockholders with at least some of the incremental
value from synergy.
Wrong Discount Rate
Synergyusuallygeneratesincrementalcashflowsoverfuture
periods,andvaluingthesecashflowsrequiresadiscountrate.
Usingthewrong discountrate onsynergy cash flowswill
resultinsynergybeingmisvalued.Thegeneralprinciplethat
governstheestimationofdiscountrates,whichisthatthey
should reflectthe nondiver-sifiable risk in the cash flows,
continuestoholdwhenitcomestocashflowsfromsynergies.