Evaluation Acquisition

Question

You are an investment bank intern and your first job is to help with an acquisition project. Your client, Purifier, is an industry leader in the air conditioning business. Recently, Purifier approached your investment bank and expressed its interests in acquiring a start-up called IntelAir. Your project manager assigned you the task of evaluating this acquisition. After one week of research, you gathered the following information about IntelAir.

IntelAir was founded two years ago by a few college dropouts. IntelAir has developed a proprietary temperature sensor antenna and a patented air purifying system. Purifier thinks that acquiring IntelAir will bring valuable economic synergies and expand Purifier’s market share.

IntelAir has signed contracts with several temperature sensor companies to deliver its antenna. The contract specifies that over the next ten years (years 1 to 10), IntelAir would deliver their most up-to-date sensor antennas for $1000/unit. The yearly order volume is 5000 units for a total revuenue of $5,000,000. After 10 years, IntelAir anticipates that there will be no more demand for antenna due to landscape changes in the technology space.

The all-inclusive cost of sensor production is $700/unit. However, IntelAir expects that in year 5, there will be a major technology upgrade. IntelAir will incur a one-time upgrading expense in year five, which is not included in the previous all-inclusive cost. The upgrading expense is $800,000.

Also, Purifier intends to sell the air purifying system patent one year after the acquisition (year 1). The patent’s expected selling price is $2,000,000.

Purifier currently uses a discount rate of 10%.

What is the maximum Purifier should pay for IntelAir? (please use two decimal digits in your answer)

Answer 1

The maximum Purifier should pay for IntelAir is $10,538,295.42.

To solve this problem, we need to calculate the present value of all the future cash flows IntelAir will generate. Since money received in the future is worth less than money received today, we discount these cash flows using the 10% discount rate.

Step 1: Calculate the annual profit from sensor antennas.

IntelAir sells 5,000 antennas per year at $1,000 each.

Annual revenue = 5,000 x $1,000 = $5,000,000

Annual production cost = 5,000 x $700 = $3,500,000

Annual profit = $5,000,000 - $3,500,000

Annual profit = $1,500,000

IntelAir will earn $1,500,000 annually for 10 years.

Step 2: Calculate the present value of the annual profits.

Since the company earns the same amount each year for 10 years, we can use the present value of an annuity formula.

PV = Annual Cash Flow x [1 - (1 + r)^(-n)] / r

Here:

Annual Cash Flow = $1,500,000

r = 0.10

n = 10 years

PV = $1,500,000 x [1 - (1.10)^(-10)] / 0.10

PV = $9,216,850.66

Step 3: Calculate the present value of the patent sale.

Purifier plans to sell the patent for $2,000,000 in year 1.

PV = $2,000,000 / 1.10

PV = $1,818,181.82

Step 4: Calculate the present value of the technology upgrade.

IntelAir must spend $800,000 in year 5. Since this is an expense, we subtract it from the company's value.

PV = $800,000 / (1.10)^5

PV = $496,737.06

Step 5: Calculate the maximum acquisition price.

We add the present value of annual profits and the patent sale, then subtract the technology upgrade expense.

Maximum Price = PV of Profits + PV of Patent - PV of Upgrade

Maximum Price = $9,216,850.66 + $1,818,181.82 - $496,737.06

Maximum Price = $10,538,295.42

Final Answer: $10,538,295.42

Purifier should pay no more than $10,538,295.42 for IntelAir based on the projected cash flows provided.

Paying exactly this amount would result in a net present value (NPV) of zero, meaning Purifier would earn its required 10% return. Paying less would create a positive NPV.

This valuation assumes the annual cash flows occur at year-end and excludes any additional synergies, taxes, or acquisition costs not specified in the question.