Question

Cautionary​ Tales, Inc., is considering the acquisition of Danger Corp. at its asking price of ​$ 100,000. Cautionary would immediately sell some of​ Danger's assets for ​$ 10,000 if it makes the acquisition. Danger has a cash balance of ​$ 1,000 at the time of the acquisition. If Cautionary believes it can generate​ after-tax cash inflows of ​$ 20,000 per year for the next 10 years 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. The net present value of the acquisition is ​$ .  ​(Round to the nearest​ dollar.)

Answer 1

The NPV is computed as shown below:

= Initial investment + Present value of future cash flows

Present value is computed as follows:

= Future value / (1 + r)ⁿ

So, the NPV is computed as follows:

Initial investment is computed as follows:

= - $ 100,000 + 10,000 + $ 1,000

= - $ 89,000

So, the NPV will be as follows:

= - $ 89,000 + $ 20,000 / 1.09¹ + $ 20,000 / 1.09² + $ 20,000 / 1.09³ + $ 20,000 / 1.09⁴ + $ 20,000 / 1.09⁵ + $ 20,000 / 1.09⁶ + $ 20,000 / 1.09⁷ + $ 20,000 / 1.09⁸ + $ 20,000 / 1.09⁹ + $ 20,000 / 1.09¹⁰

= $ 39,353.15 Approximately

Since the NPV is positive, hence it is advisable to make the acquisition.

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