Finance Question

Question

Company B wants to buy Company A.

 

Assume that company A has pre-tax cash flows of $5 Billion per year, with no growth expected in the future. In addition, the firm is subject to a 35% corporate tax rate and Company B has determined that an appropriate discount rate for the firm is 18%.

 

What is the maximum amount that Company B should buy Company A for?

Answer 1

Use the perpetual annuity formula with a payment of 5(1-0.35) billion and a discount rate of 0.18.

 

The maximum amount Company B should pay for Company A is the present value of the annuity.