The following table shows the projected free cash flows of an acquisition target
ID: 2745400 • Letter: T
Question
The following table shows the projected free cash flows of an acquisition target. The potential acquirer wants to estimate its maximum acquisition price at an 8 percent discount rate and a terminal value in year 5 based on the perpetual growth equation with a 4 percent perpetual growth rate.
Year
1
2
3
4
5
Free cash flow
–$800
–$400
$0
$200
$700
a. Estimate the target’s maximum acquisition price.
b. Estimate the target’s maximum acquisition price when the discount rate is 7 percent and the perpetual growth rate is 5 percent.
c. What is the percentage change in the maximum acquisition price when the discount rate is reduced one percentage point and the perpetual growth rate is increased one percentage point?
Year
1
2
3
4
5
Free cash flow
–$800
–$400
$0
$200
$700
Explanation / Answer
a) Terminal Value in year 5 = (700 + 4 % of 700) / 0.08 - 0.04
= 728 / 0.04
= $ 18200
Present value of free cash flows = (-) 800 * Present value factor for year 1 @ 8 % + (-) 400 * Present value factor for year 2 @ 8 % + 0 * Present value factor for year 3 @ 8 % + 200 * Present value factor for year 4 @ 8 % + [18200 + 700 ] * Present value factor for year 5 @ 8 %
= (-) 800 * 0.926 + (-) 400 * 0.857 + 0 + 200 * 0.735 + 18900 * 0.681
= (-) 740.80 + (-) 342.80 + 147 + 12870.90
= $ 11934.30
Conclusion:- Target's maximum acquisition price = $ 11934.30
b) Terminal Value in year 5 = (700 + 5 % of 700) / 0.07 - 0.05
= 735 / 0.02
= $ 36750
Present value of free cash flows = (-) 800 * Present value factor for year 1 @ 7 % + (-) 400 * Present value factor for year 2 @ 7 % + 0 * Present value factor for year 3 @ 7 % + 200 * Present value factor for year 4 @ 7 % + [36750 + 700 ] * Present value factor for year 5 @ 7 %
= (-) 800 * 0.935 + (-) 400 * 0.873 + 0 + 200 * 0.763 + 37450 * 0.713
= (-) 748 + (-) 349.20 + 152.60 + 26701.85
= $ 25757.25
Conclusion:- Target's maximum acquisition price = $ 25757.25
c) Percentage Change in the maximum acquisition price = 25757.25 - 11934.30 / 11934.30
= 13822.95 / 11934.30
= 1.158 i.e., 115.80 % (approx)
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.