Question

ABC Corp acquires a firm for $9.7bn using a cost of capital of 11%. The CFO is certain the acquisition will have conventional cash flows and a payback period of 5.0 years (ignoring time value of money). But she is uncertain whether the acquisition will potentially turn out really bad for the firm. She wants your advice – can you estimate an upper limit on how much value can be destroyed by this acquisition?

Answer 1

Answer:

Initial Invetsment = $9.7 billion = $9,700,000,000

Payback period = 5 Years

Given that the acquisition has conventional cash flows but year wise cash flow details are not given. Further cash flows after payback period are also not known.

From the given information, worst case will be that entire cash inflow of $9.7 billion is at the end of year 5.

Net present value of worst case = 9700000000 / 1.11^5 - 9700000000 = - $3,943,522,117.83 or ($3,943,522,117.83)

Estimated upper limit on value that can be destroyed by this acquisition = $3,943,522,117.83