Tools

A unit of Stanley Works, a provider of tools, hardware and door systems, offered $45.3 million to purchase security systems company Frisco Bay Industries Ltd., in early 2004 in order to diversify Stanley’s business. At the time, Frisco Bay had annual sales of $40 million. One way in which to value the purchase of another company is to assume that it will continue its normal operations indefinitely. If the annual rate of interest is 12%, determine whether the following cash flows are equivalent to the purchase price, which is assumed to be a present value:
(a) $5.4 million in annual profits that continue indefinitely
(b) $4.0 million in annual profits that grow by $0.1 million per year thereafter indefinitely

I know you can make cash flows and use present value on Excel, but does anyone know a good process to do so?

Disregarding Excel,

(a) $5.4 million < 0.12 * $45.3 million = $5.436 million; The cash flow will never equal the value of the $5.4 million % 0.12 %/yr. (Wow, some interest rate!)

(b) After 15 years, the growth will result in a yearly return greater than the expected interest. After still more years, the total profits will exceed those of the total interest the original purchase price would have accrued. This is more than equivalent. However, there is the risk that the expected values may change. Had Stanley offered $45 million, that would be equivalence. Profit would have to be expected from total Stanley sales considering diversity.

.

5.4 million is greater than 12% of 45.3 million and so a good deal for Stanley if accepted.

(b) It would take 8 years for the 4 million plus 0.1 million/yr to even equal 12 % of 48 million

One Response

1. Bert K Says:
   July 7th, 2010 at 10:08 am

   Disregarding Excel,

   (a) $5.4 million < 0.12 * $45.3 million = $5.436 million; The cash flow will never equal the value of the $5.4 million % 0.12 %/yr. (Wow, some interest rate!)

   (b) After 15 years, the growth will result in a yearly return greater than the expected interest. After still more years, the total profits will exceed those of the total interest the original purchase price would have accrued. This is more than equivalent. However, there is the risk that the expected values may change. Had Stanley offered $45 million, that would be equivalence. Profit would have to be expected from total Stanley sales considering diversity.

   .

   5.4 million is greater than 12% of 45.3 million and so a good deal for Stanley if accepted.

   (b) It would take 8 years for the 4 million plus 0.1 million/yr to even equal 12 % of 48 million
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