Question

Cautionary​ Tales, Inc., is considering the acquisition of Danger Corp. at its asking price of​$200,000. Cautionary would immediately sell some of​ Danger's assets for ​$20,000 if it makes the acquisition. Danger has a cash balance of ​$2,000 at the time of the acquisition. If Cautionary believes it can generate​ after-tax cash inflows of ​$30,000 per year for the next 5 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 8%cost of capital.

The net present value of the acquisition is ​$_____(Round to the nearest​ dollar.)

Based on the NPV​, should Cautionary make the​ acquisition? Yes or No

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:

= - $ 200,000 + $ 20,000 + $ 2,000

= - $ 178,000

So, the NPV will be as follows:

= - $ 178,000 + $ 30,000 / 1.08 + $ 30,000 / 1.08² + $ 30,000 / 1.08³ + $ 30,000 / 1.08⁴ + $ 30,000 / 1.08⁵

= - $ 58,219 Approximately

Since the NPV is negative, hence the acquisition shall not be done.

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