Question

a. Your company is evaluating a potential acquisition with annual revenue of $500 million, operating profit of $50 million and after-tax cash flow of $30 million. Your corporate development team believes it has found synergies that can save $50 million in costs which can be realized by year 3. Assuming a 10% weighted average cost of capital what is the maximum price your company should pay for this acquisition?

b. Suppose the potential deal in a question is for a highly cyclical company at peak earnings. If there is a 40% probability of recession by Year 3 and the impact would be negative by 25% of current profit estimates how does this change your answer for a?

Answer 1

Maximum value to be paid for the acquisition: $713.2 million

Year	1	2	3	Terminal value
After tax Cash flow	30	30	80	800
Discount factor at 10%	0.909	0.826	0.751	0.751
Discount cash flow	27.3	24.8	60.1	601.1
Value of acquisition				713.2
Terminal value	800

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B. In Case of recession, maximum value to be paid for acquisition is $641.9 million

cash flow will be impacted negatively = - 40% * 25% = -10%

Year	1	2	3	Terminal value
After tax Cash flow (negative impact of -10%)	27	27	72	720
Discount factor at 10%	0.909	0.826	0.751	0.751
Discount cash flow	24.5	22.3	54.1	540.9
Value of acquisition				641.9
Terminal value	720

Excel formula: