You are considering purchasing a business that is being auctioned to many strategic buyers (it's being sold
Question:
You are considering purchasing a business that is being auctioned to many strategic buyers (it's being sold in a competitive market). You estimate that the project has a CAPM beta of 1.5. You believe the market risk premium to be 8% and the risk-free rate to be 4%.
a) What annual return would you need to expect to earn (what is the expected return) for this business if the CAPM holds?
b) You estimate that the business will have the following revenues and costs
Year | 0 | 1 | 2 | 3 | 4 | 5 |
Revenue | -- | $320,000 | $550,000 | $700,000 | $750,000 | $800,000 |
Cost of Goods | -- | $200,00 | $400,000 | $400,000 | $500,000 | $600,000 |
Investment Required | $100,000 |
Where investments can be depreciated straight line over 5 years. Your business pays a 30% tax and you don't believe any net working capital will be required. How much would you be willing to pay for the business (what is it worth)? Hint: use your CAPM expected return from part a as your discount rate.
Expert Answer:
a To calculate the expected return for the business using the Capital Asset Pricing Model CAPM we can use the following formula Expected return Riskfr... View the full answer
