Question

Cautionary​ Tales, Inc., is considering the acquisition of Danger Corp. at its asking price of ​$180,000. Cautionary would immediately sell some of​ Danger's assets for ​$18,000 if it makes the acquisition. Danger has a cash balance of ​ 1,800 at the time of the acquisition. If Cautionary believes it can generate​ after-tax cash inflows of ​$28,000 per year for the next 8years from the Danger​ acquisition, should the firm make the​ acquisition? Base your recommendation on the net present value of the outlay using​ Cautionary's 9​% cost of capital.

Answer 1

INITIAL OUTLAY DUE TO ACQUISITION OF DANGER CORP.

Purchase consideration for acquiring danger corp. =$180,000

less :Benefits/savings due to acquisition   

sale of asset of danger corp. =$18,000

cash balance (note.1) =$1800

Net outlay/outflow on acquisition =$160,200

Note: Since we know that all assets & liabilities gets transfered during merger or i say if one company is acquired by other , cash is also a benefit which will arise as a result of acquisition ,hence deducted while calculating net cash outlay

AFTER MERGER

It is expected that after acquisition it will generate $ 28000 cash inflow per year till 8th year hence the same is multiplied with present value factor till 1 to 8th year for calculating present value of cash inflow.

present value of cash inflow = $28,000* (PVF@ 9% ,1 to 8 yrs)

=$28,000*5.535

=$154980

NET PRESENT VALUE

Present value ofCash Inflow (a) $154980

Less: Initial Cash outlay (b) ( $160200)

Net present value (a-b) ($5220)

Conclusion: since the net present value is negative cautionary tales Inc .should not opt for acquisition of danger corp.