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Modified on 2011/08/08 14:07 by swathen Categorized as Uncategorized

Joey owns a small chemical plant called Chemco. Chemco, despite the effects of the recent recession, is doing fine. Chemco is doing so well, in fact, that they have excess cash. Chemco decides to look for a suitable investment for the free cash flow of the company.

The next day Joey attends his trade organization meeting. At this meeting he meets the CEO of Chemicalventures, his main competitor to Chemco. They resolve to set aside their differences and meet for lunch. At this lunch meeting, Joey finds out that Billy has decided to sell Chemicalvenutres and wonders if Chemco would be interested in purchasing Chemicalventures. Billy assures Joey that the investment will be worth his time and effort.

Joey, the next day, contacts his board of directors. The board of directors of Chemco is interested in the idea as long as it is financed with debt. First, however, they require the financials of the company as well as the adjusted present value of the deal.

Joey talks to Billy, who sends the company financials over to Joey. Joey begins his preliminary research by Googling "adjusted present value calculator". Unsatisfied with what he sees, Joey sends the Chemicalventures financials over to his top financial analyst.

The analyst performs this calculation based on the Chemicalventures financials:

If: Investment = \$500,000 Cashflow from equity = \$25,000 Cost of equity = 20% Cost of Debt = 7% Interest on debt = 7% Tax = 35% And the deal is financed half with equity and half with debt

NPV = -\$500,000 + (\$25,000 / 20%) = -\$375,000 PV = (35% x \$250,000 x 7%) / 7% = \$87,500

-\$375,000 + \$87,500 = -\$287,500 --> Bad Deal

Joey is pleased to find these results because they have saved him from making a poor business decision. He contacts Billy to tell him that, unfortunately, Chemco can not purchase Chemicalventures.