ACCA Strategic Professional · Advanced Financial Management · Valuation for acquisitions and mergers
Which of the following is a recognised limitation of using the dividend valuation model to value a target company's shares in an acquisition?
The key limitation is that the model is very sensitive to the growth rate and cost of equity estimates, and it reflects dividends to a minority shareholder rather than the benefits of control or synergies in an acquisition. It does not use free cash flows or WACC.
- AIt is highly sensitive to the estimated growth rate and cost of equity, and values only a minority holding's dividend stream rather than control benefitsCorrect
- BIt cannot be applied to any company that pays a dividend
- CIt automatically includes the value of synergies from the combination
- DIt uses free cash flows to the firm discounted at the WACC
Explanation
The model discounts expected dividends, so small changes in g or ke change value greatly, and it reflects a minority investor's cash flows, not control or synergy. It is designed for dividend-paying firms and does not use FCFF or WACC.
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