Question

1. Calculate the present value of the company based on the given interest rate and expected revenues over time. 2. Suppose the risk of the company changes based on an internal event. Recalculate the present value of the company. 3. Suppose that a potential buyer has offered to buy this company in five years. Based on the present value you calculated above, what would be a reasonable amount for which the company should be sold at that future time? B. What are the implications of the change in present value based on risk? In other words, what does the change mean to the company, and how would you, as a financial manager, interpret it? Be sure to justify your reasoning. C. Based on the future value of the company that you calculated, and being mindful of the need to effectively balance portfolio risk with return, what recommendation would you make about purchasing the company as an investment at that price? Be sure to substantiate your reasoning.

1. Original Scenario from Milestone 1 - Time Value of Money using 8%
Interest Rate	8.00%
		FCF1	FCF2	FCF3	FCF4	FCF5
Amounts*		113	111	108	101	97
Pv*		(104.63)	(95.16)	(85.73)	(74.24)	(66.02)
Total Pv*		(425.78)
*In millions
2. Change in interest rate and its implications - Lower Interest Rate (5%)
Interest Rate	5.00%
		FCF1	FCF2	FCF3	FCF4	FCF5
Amounts*		113	111	108	101	97
Pv*		(107.62)	(100.68)	(93.29)	(83.09)	(76.00)
Total Pv*		(460.69)
*In millions
3. Change in interest rate and its implications - Higher Interest Rate (15%)
Interest Rate	15.00%
		FCF1	FCF2	FCF3	FCF4	FCF5
Amounts*		113	111	108	101	97
Pv*		(98.26)	(83.93)	(71.01)	(57.75)	(48.23)

Answer 1

1. Present value of the company at 8% = 113/1.08 + 111/1.08^2 +108/1.08^3 + 101/1.08^4 + 97/1.08^5 = 425.78

2. Present value at lower risk (5%) = 113/1.05 + 111/1.05^2 +108/1.05^3 + 101/1.05^4 + 97/1.05^5 = 460.69

Present value at higher risk (15%) = 113/1.15 + 111/1.15^2 +108/1.15^3 + 101/1.15^4 + 97/1.15^5 = 359.18

3. Reasonable value would be at a reasonable interest rate (8%) neither high, nor low. So, the company can be purchased at 425.78 Million

B. The change means what happens if the cost of capital increase. When the business is acquired would the cost of capital increase of decrease. The cost of capital would be calculated based on the nature of the business being acquired. That is, if the business being acquired is a stable one, then cost of capital will be lower, else higher.

C. By considering the risk, I would suggest the use of equal weights for each category of risk. I would say that there is a 33% chance of normal 8%, 33% weights for the other two Interest rates.

Given the above scenario, the net purchase price for the business would be = 0.33*425.78 +0.33*460.69+0.33*359.18 = 411.06

So, the price I would offer for the business = $411.06 Million