ylon Co.is a uS firm that provides technology software for the government of Sin
ID: 2796817 • Letter: Y
Question
ylon Co.is a uS firm that provides technology software for the government of Singapore. It will be 000,000 at the end of each of the next five years. The entire amount of the payment represents earnings since Zylon created the technology software years ago. Zylon is subject to a 30 percent corporate income tax rate in the United States. Its other cash inflows (such as revenue) are expected to be offset by its other cash outflows (due to operating expenses) each year, so its profits on the Singapore contract represent its expected annual net cash flows. Its financing costs are not considered within its estimate of cash flows. The Singapore dollar (SS) is presently worth $.60, and Zylon uses that spot exchange rate as a forecast of future exchange rates. The risk-free interest rate in the United States is 6 percent while the risk-free interest rate in Singapore is 14 percent. Zylon's capital structure is 60 percent debt and 40 percent equity. Zylon is charged an interest rate of 12 percent on its debt. Zylon's cost of equity is based on the CAPM. It expects that the U.S. annual market return will be 12 percent per year. Its beta is 1.5. Quiso Co., a U.S. firm, wants to acquire Zylon and offers Zylon a price of $10,000,000. n's owner must decide whether to sell the business at this price and hires you to make a Estimate the NPV to Zylon as a result of selling the business, and make a recommendation about whether Zylon's owner should sell the business at the price offered. Zylo recommendation.Explanation / Answer
Ans. Evaluation of Price offered Quiso co.
Offer price $10000000
Calculation of WACC
Ke = 6%+(12-6)X1.5 = 15%
Kd = 12(1-.30) = 8.40%
Debt/equity ratio = 60:40
WACC = 8.40X.60+15X.40 = 5.04+6 = 11.04%
Annual CF S$7000000
Cash flow in $4200000 (7000000X.60)
Less: Tax @30% ($1260000)
Net Cash flow $2940000
Calculation of present value of Cash flow for 5yrs
= $2940000X Pv @11.04% for 5yrs
= $2940000X3.6922 = $10855068
Comment: So offer price is less than Present value of future cash flow, so Zylon would not sell the business with offered price becuause future cash flow is more than offered price.
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