According to the Wall Street Journal, merger and acquisition activity in the fir

Question

According to the Wall Street Journal, merger and acquisition activity in the first quarter of 2004 rose to 5.3 billion- an investment level not seen since the second quarter of 2001. Approximately three fourths of the 78 first quarter deals occurred between information technology companies. The largest IT transaction of the quarter was EMC's $625 million acquisition of VMWare. The VMWare acquisition broadened EMC's core data storage device business to include software technology enabling myltiple operating systeks such as Windows, Linux, and Novell Inc.'s etware- to simultaneously and independently run on the same Intel based server or workstationl Suppose that at the time of the acquisition the weak economy led many analysts to project that VMWare's profits would grow at a constant rate of 1% for the forseeable future, and that the company's annyal net income was $50.72 million. If EMC's estimated opportunity cost of funds is 10%, as an analyst how would you view the acquisition ? Would your conclusion change if you knew that EMC had credible information that the economy was on the verge of an expansion period that would boost VMWare's projected annual growth rate to 3% for the foreseeable future? Explain.

Explanation / Answer

Hi, I hope that you are doing good folk. Before moving straight towards solution, it is very necessary for us to understand the basic concept behind the question.

See, We have to do analyze that whether the acquisition made by EMC is profitable or not. Now, it is very simple that if what we receive from acquisition is more than what we pay for acquisition than deal is profitable. i.e. if outflow of money today (herein after called as PVo) is less than present value of all the inflows from deal today (herein after called as PVi) than Deal should be acceptable and if PVo=PVi , than we should be neutral on deal.

There are various methods to calculate Present Value to analyze such critical problems. For Eg Discounted Cash Flow (DCF) Method, etc. but what suits the question best is Gordon

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