Question

Weston Hep Cash acquisition decision Benson Oil is being considered for acquisition by Dodd Oil The combination, Dodd believes, would increase its cash inflows by $25,000 for each of the next 5 years and by $52,000 for each of the following 5 years. Benson has high financial leverage, and Dodd can expect its cost of capital to increase from 11% to 14% if the merger is undertaken. The cash price of Benson is $135,000 a. Would you recommend the merger? b. Would you recommend the merger if Dodd could use the $135,000 to purchase equipment that will return cash inflows of $36,000 per year for each of the next 10 years? a. The nel present value of the merger is SL (Round to the nearest cent)

Answer 1

Cost of capital = " r " = 0.14

Present value of annuity for 1 to 5 Years = [ 1 - (1.14)^-5 ] / 0.14 = 3.43308097

Present value of annuity for 1 to 10 Years = [ 1 - (1.14)^-10 / 0.14 = 5.21611565

Present value of annuity from 5 to 10 years = 5.21611565 - 3.43308097 = 1.78303468

NPV of the merger = Present value of cash flows - Cash price ( i.e Investment )

= 25000 * 3.43308097 + 52000 * 1.78303468 - 135,000

= 178,544.83 - 135,000

= 43544.83

Question - (b)

NPV of the alternative Investment = Annual cash inflow * PVA - Investment

= 36000 * 5.21611565 - 135,000

= 52780.16

The alternative investment had a higher NPV compared to that of Merger. Hence merger is NOT RECOMMENDED