Question

Rive Rocks, whose WACC is 11.3%, is considering an acquistio of Raft Adventures (whose WACC is 15.5%). What is the appropriate discount rate for RiverRocks to use to evaluate the acquisiton? Why The appropriate discount rate for RiverRocks to use to evaluate the acquisitionisRound to one decimal place) Why? (Select the best choice below) Lj. (Round to one decimal place.) O A Raft Adventures: WACC is the most appropriate dscount rate to account for the risk of Raft Adventures' cash fows ? B. The risk-froo rate will best account for the risk of Raft Adventures, cash fows since RherRocks wil pay cash for the transaction. O C. An average WACC from RiverRocks and Raft Adventures will best account for the risk of Raft Adventures' cash flows O D. RiverRocks' WACC is the most appropriate discount rale to account for the risk of Ralt Adventures' cash fows.

Answer 1

The most appropriate discount rate to use for RiverRocks' evaluation of the acquisition of Raft Adventures is Raft Adventures' own WACC of 15.5%, as it reflects the specific risks associated with Raft Adventures' cash flows.

Step-by-step explanation:

The appropriate discount rate for RiverRocks to use to evaluate the acquisition of Raft Adventures should reflect the risk of the cash flows of the business being acquired. Since Raft Adventures has a Weighted Average Cost of Capital (WACC) of 15.5%, which is likely to include a risk premium for its specific business risks, this would be the most suitable rate to use. RiverRocks' WACC of 11.3% may not adequately represent the risk associated with Raft Adventures' cash flows and, therefore, may not be the proper discount rate for this investment decision.

Using a combined average WACC of both companies would dilute the specific risk profile of Raft Adventures, which could lead to an inappropriate valuation. Furthermore, the risk-free rate would not account for the business risk inherent in Raft Adventures' cash flows, making it unsuitable for discounting purposes in this scenario.