Hi all I'm a bit confused with the solution in the ASET to question 19 part (i) of the October 2012 paper. In the "Gearing" section to the solution, it says that either acquisition will increase Dayton's equity - this is fine. It then goes on to say that it's level of debt may be unchanged (if it pays cash for the acquisition) or may increase (if it borrows). Surely, even if the acquisition is funded by cash, the level of debt would still increase (possibly only slightly) because both companies have debt finance. So I would have written that the size of the increase in debt will depend on how Dayton finances the purchase: if it borrows to fund the acquisition this will increase the debt by more than how much it would increase if cash was used. Am I missing something here?? Thanks in advance
debt on acquisition I am not sure I agree. If a company buys another company for cash, it certainly inherits all the debt of the acquired company, so total debt will rise in the combined company. But the assets of the combined company and possibly its equity value, will also rise, so the gearing (debt to equity) may not necessarily rise. I agree though, that, if the equity doesnt rise as a result of the acquisition, and debt certainly will, then gearing is likely to rise.
Thanks Colin. I think the wording in the solution isn't great. I do agree that gearing gearing may remain constant but the solution says that debt (not gearing) will remain constant - which isn't true. Would you agree? Thanks
gearing Yes - I agree that debt will probably rise. We will look at that next time the course comes up for revision. thanks
