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Unformatted text preview: sets. This is a capital budgeting problem (see Chapters 8, 9, and 10), because an initial cash outlay is made
to acquire assets, and as a result, future cash inflows are expected.
EXAMPLE Clark Company, a major manufacturer of electrical transformers, is interested in
acquiring certain fixed assets of Noble Company, an industrial electronics company. Noble, which has tax loss carryforwards from losses over the past 5 years,
is interested in selling out, but it wishes to sell out entirely, not just to get rid of
certain fixed assets. A condensed balance sheet for Noble Company follows.
Cash Liabilities and Stockholders’ Equity
$ 2,000 Marketable securities
Accounts receivable 0
8,000 Inventories 10,000 Machine A Total liabilities
Total liabilities and
stockholders’ equity $ 80,000
$200,000 10,000 Machine B 30,000 Machine C 25,000 Land and buildings
Total assets 115,000
$200,000 Clark Company needs only machines B and C and the land and buildings.
However, it has made some inquiries and has arranged to sell the accounts receivable, inventories, and machine A for $23,000. Because there is also $2,000 in
cash, Clark will get $25,000 for the excess assets. Noble wants $100,000 for the
entire company, which means that Clark will have to pay the firm’s creditors
$80,000 and its owners $20,000. The actual outlay required of Clark after liquidating the unneeded assets will be $75,000 [($80,000 $20,000) $25,000]. In
other words, to obtain the use of the desired assets (machines B and C and the
land and buildings) and the benefits of Noble’s tax losses, Clark must pay
$75,000. The after-tax cash inflows that are expected to result from the new
assets and applicable tax losses are $14,000 per year for the next 5 years and
$12,000 per year for the following 5 years. The desirability of this asset acquisition can be determined by calculating the net present value of this outlay using
Clark Company’s 11% cost of capital, as shown in Table 17.2. Because the net
present value of $3,072 is greater than zero, Clark’s value should be increased by
acquiring Noble Company’s assets. Acquisitions of Going Concerns
Acquisitions of target companies that are going concerns are best analyzed by
using capital budgeting techniques similar to those described for asset acquisitions. The methods of estimating expected cash flows from an acquisition are 722 PART 6 Special Topics in Managerial Finance TABLE 17.2 Net Present Value of Noble
Company’s Assets Year(s) Cash inflows
(1) Present value
factor at 11%
(2) Present value
(3) 1–5 $14,000 3.696a $51,744 6 12,000 0.535b 6,420 7 12,000 0.482b 5,784 8 12,000 0.434b 5,208 9 12,000 0.391b 4,692 10 12,000 0.352b
Present value of inflows
Less: Cash outlay required
Net present valuec 4,224
$ 3,072 aThe present value interest factor for an annuity, PVIFA, with a 5-year
life discounted at 11% obtained from Table A–4.
bThe present value interest factor, PVIF...
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