HiHo Inc.is evaluating a merger with the following cash flows:
• Years 1 to 3 Incremental Cash Flows: $10 million each year
• Value of incremental cash flows after year 3 as of the end of year 3: $30 million
• Discount rate = 10 percent
What is the most HiHo should pay for this merger?

Question

Quizplus · Accepted Answer

To find out the most HiHo should pay for this merger, we need to calculate the present value of all incremental cash flows. We can use the discounted cash flow (DCF) method to calculate this.

PV of cash flows for years 1 to 3 = $10 million x annuity factor (10%, 3 years) = $10 million x 2.48685 = $24.87 million
PV of cash flow for year 4 = $30 million / (1.10)^3 = $20.51 million

Total PV of incremental cash flows = $24.87 million + $20.51 million = $45.38 million

Therefore, the most HiHo should pay for this merger is $45.38 million, which is closest to C) $47.41 million.

HiHo IncIs Evaluating a Merger with the Following Cash Flows