Carlisle Enterprises, a specialty pharmaceutical manufacturer, has been losing market share for three years since several key patents have expired. The free cash flow to the firm in 2002 was $10 million. This figure is expected to decline rapidly as more competitive generic drugs enter the market. Projected cash flows for the next five years are $8.5 million, $7.0 million, $5 million, $2.0 million, and $.5 million. Cash flow after the fifth year is expected to be negligible. The firm’s board has decided to sell the firm to a larger pharmaceutical company interested in using Carlisle’s product offering to fill gaps in its own product offering until it can develop similar drugs. Carlisle’s cost of capital is 15%. What purchase price must Carlisle obtain to earn its cost of capital?
To find the purchase price that Carlisle must obtain to earn its cost of capital, we are required to find out the present value of projected cash flows for next 5 years. Since, the cost of capital is 15%, we can use 15% as the discounting rate.
The formula to calculate present value is:
where, r = discounting rate
and, t = number of years
Following table shows the present values of future cash inflows for next 5 years.
From the table above, we have found out the total PV of future cash inflows, i.e., $17.36 million. This is the purchase price that Carlisle must obtain to earn 15% cost of capital.
Get Answers For Free
Most questions answered within 1 hours.