ACCA · Question 01 · Advanced Investment Appraisal and M&A Valuation

SECTION A: STRATEGIC CASE STUDY

This question is worth 50 marks.

AuraGrid Co is a large, listed European utility company specializing in renewable energy infrastructure. As part of its 'Global Transition 2030' strategy, AuraGrid is looking to expand its footprint into emerging markets. The Board of Directors has identified SolAndes, an unlisted solar farm operator based in a South American country (the Republic of Sanora), as a potential acquisition target.

SolAndes is currently owned by a consortium of private equity investors who are looking to exit. AuraGrid plans to acquire 100% of the equity of SolAndes. The acquisition will be financed entirely by a new issue of subsidized 'Green Bonds' in Europe, which will significantly alter the capital structure of the combined entity.

EXHIBIT 1: Financial Projections for SolAndes
AuraGrid's corporate finance team has prepared the following financial forecasts for SolAndes for the next four years (Years 1 to 4). After Year 4, the free cash flows to the firm (FCFF) are expected to grow at a constant rate of 3% per annum in perpetuity.

• Year 1 FCFF: $45 million
• Year 2 FCFF: $52 million
• Year 3 FCFF: $60 million
• Year 4 FCFF: $65 million

These cash flows are stated in US Dollars ($), which is the functional currency used for international transactions by both companies, mitigating direct local currency exposure.

EXHIBIT 2: Financing and Cost of Capital

• AuraGrid's current ungeared cost of equity is estimated at 9.5%.
• The new Green Bonds will raise $500 million at a subsidized pre-tax interest rate of 4.0% per annum.
• Issue costs for the Green Bonds will be 2% of the gross amount raised. These issue costs are NOT tax-deductible.
• The corporate tax rate in both Europe and Sanora is 25%.
• AuraGrid expects to maintain the $500 million debt level in perpetuity to fund SolAndes' operations.

EXHIBIT 3: Synergies and Restructuring
If the acquisition proceeds, AuraGrid expects to realize post-tax operational synergies of $8 million per year, commencing in Year 1 and continuing in perpetuity. However, to achieve these synergies, AuraGrid will incur a one-off post-tax restructuring cost of $15 million in Year 0.

EXHIBIT 4: Regulatory and Strategic Context
The Republic of Sanora has recently experienced political volatility. The government has discussed implementing strict capital controls and potential windfall taxes on foreign-owned energy infrastructure. The Board of AuraGrid is divided on the acquisition. The CEO believes the strategic foothold in South America is worth the risk, while the Chief Risk Officer (CRO) is deeply concerned about the regulatory environment and the assumption that the Green Bond financing will remain subsidized if Sanora's sovereign credit rating is downgraded.

REQUIREMENTS:

Write a report to the Board of Directors of AuraGrid Co that covers the following:

(a) Calculate the maximum price AuraGrid Co should pay for the equity of SolAndes using the Adjusted Present Value (APV) method. Show all relevant calculations for the base case present value, the present value of financing side effects, and the net synergies. (24 marks)

(b) Critically evaluate the assumptions made in your APV calculation in part (a) and discuss why APV is a more appropriate valuation method for this transaction compared to the traditional Weighted Average Cost of Capital (WACC) approach. (10 marks)

(c) Advise the Board on the specific strategic and regulatory risks associated with acquiring infrastructure assets in emerging markets like Sanora, and suggest mitigation strategies AuraGrid could employ. (12 marks)

(d) Professional marks will be awarded for the format, structure, tone, and clarity of the report. (4 marks)