Question

Fly-by-night couriers is analyzing the possible aquistion of flash-in-the-pan restaurants. Neither has any debt. The forecasts by Fly-by-Night show that the purchase would increease total annual after tax cash flows by $600,000 indefinetely. The current market value of Flash-in-the-pan is $10 Million. The current market value of Fly-by-night is $35 Million. The appropriate discount rate for any change in cash flows form the merger is 8 percent.

What is the most that Fly-by-night would be willing to pay for flash in the pan?

A) 10,000,000

B) 17,500,000

C) 16,500,000

D) 19,500,000

E) None of the above

Answer 1

Solution :

Fly-by-night couriers is trying a possible acquisition of flash-in-the-pan restaurants. So the value that this flash-in-the-pan restaurant will bring to Fly-by-night couriers will be equal to increase in annual cash flow.

Here annual cash flow = 600,000

Discount rate = 8%

Synergy value : Since this will continue till perpetuity so Total value using perpetuity formula

= Annual Cash flow / Discount rate = 600000/0.08 = 7,500,000

Market value of the restaurant = 10,000,000

Total value = Synergy value + Market value = 7,500,000 + 10,000,000 = 17,500,000

So, 17,500,000 is the maximum amount that should be paid for this acquisition

Option B is correct