CAT ltd is contemplating acquiring RAT ltdOn a successful ac

CAT ltd is contemplating acquiring RAT ltd.On a successful acquisition, the incremental cashflows will be as follows: Year: 1-5 Csh Flow (In Millions):2.5 After the fifth year , cash flows are expected to growat an annual rate of 3% forever.If the appropriate discounting rate is 10%, how much should CAT Ltd pay in order to acquire RAT Ltd?

Solution

CAT Ltd must pay $31.65 Million in order to acquire RAT Ltd

Value of the Firm = Present value of annual cash inflows + Present Value of Terminal Value

Present value of annual cash inflows

= $2.50 Million x [PVIFA 10%, 5 years]

= $2.50 Million x 3.7907868

= $9.48 million

Present Value of Terminal Value

Terminal Value = Year 5 Cash Flow / [Ke – g]

= $2.50 Million / [0.10 – 0.03]

= $2.50 Million / 0.07

= $35.71 Million

Present Value of Terminal Value = Terminal Value x [PVIF 10%, 5 Year]

= $35.71 Million x 0.6209213

= $22.17 Million

\"Therefore, Value of the Firm = $9.48 million + $22.17 Million = $31.65 Million\"