Big Red Trucking is considering the acquisition of MidWest Transportation. MidWest's asking price of $$535$ million appears to be non$-$negotiable. Big Red plans to value MidWest's cash flows using its own hurdle, which is $13\%.$ MidWest's cash flows for the next three years are projected as follows: $$60$ million in year $1,$ $$70$ million in year $2,$ and $$75$ million in year $3.$ Thereafter, the cash flows are projected to grow at a rate of $3\%$ per year in perpetuity.

Consider this information about Big Red as you work through a net present value calculation of the MidWest acquisition in questions $1$ through $3.$

Notice that MidWest's cash flows begin to grow at a constant rate of $3\%$ in year $3.$ You can consider that piece of the calculation first. To calculate the year $2$ terminal value, imagine yourself two years into the future. From the point of view of year $2,$ what is the value of the cash flows to be received in year $3$ and all future years? $(2)$Next$,$ calculate the present value of all of MidWest's future cash flows. Specifically, what is the combined present value of the year $1$ $$60$ million cash flow, the year $2$ $$70$ million cash flow, and the year $2$ terminal value you calculated in the previous question? $(3)$ Finally, what is the NPV of the potential acquisition of MidWest Transportation? $(4)$Please use the following information to answer questions $4$ and $5.$

Big Red is also considering taking on a five$-$year contract with Standard Refining to distribute refined oil products such as gasoline. The cost of the trucking equipment and terminal upgrades required to service the contract are estimated to be $$140$ million. After careful consideration of the risks associated with the Standard contract, Big Red has made the determination that its own $13\%$ hurdle rate is appropriate. The Standard contract's cash flows for the next five years are projected as follows: Standard Contract Cash Flows $($in $ millions$)$ are $$40$ in year $1,$ $$40$ in year $2,$ $$40$ in year $3,$ $$40$ in year $4,$ and $$20$ in year $5.$ Note that the contract ceases in year $5,$ so there are no additional relevant cash flows in year $6$ and beyond. Also note that the year $5$ cash flow incorporates costs associated with the environmental cleanup of equipment and storage facilities used to distribute the refined oil products.

What is the present value of the future cash flows associated with the Standard contract? $(5)$What is the NPV of the Standard Refining contract?

Answer rating: 100% (QA)

This question involves the concept of Net Present Value NPV calculation specifically for business acquisitions and contract decisions The NPV of an in... View the full answer