In 1990, John Deere is looking to acquire a company specializing in developing artificial intelligence (AI) assisted
Question:
In 1990, John Deere is looking to acquire a company specializing in developing artificial intelligence (AI) assisted agricultural machinery. A potential target is A-Eye, Inc., which has two divisions, namely, Software Development and Robotics Technology. A-Eye is a private start-up firm and has no debt in its capital structure. John Deere is considering acquiring one of A-Eye's divisions. The analyst of John Deere has collected information on historical returns on the market portfolio and the relevant industries:
Market portfolio | Covariance with the market | |||
Estimation period | Mean return | Variance | Software industry | Robotics industry |
1960-1989 | 0.10 | 0.020 | 0.028 | 0.052 |
Answer questions (a) and (b) below.
- Assume that the risk-free rate is 5%. Find the CAPM betas for the Software division and the Robotics division of A-Eye to determine the required rates of return on each division.
Despite the analyst's estimates, the manager of John Deere has his own valuation principle: "Use 15% as the discount rate for any valuation problems." Had the manager's rule been applied, for which division of A-Eye, if acquired, would John Deere end up overpaying?
Answer (no calculation required):
Financial Reporting Financial Statement Analysis and Valuation
ISBN: 978-0324302950
6th edition
Authors: Clyde P. Stickney