foundation of risk

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Joined: Sat Apr 26, 2014 7:29 am

foundation of risk

Postby sessiljoseph » Wed Apr 30, 2014 6:19 am

for the past 4 yrs companyA has been outperforming company B the corporategovernance model of company a is well respected among investors at present company A is trying to take over company B the probability that company A would be succesful in it is3and the company b stocks are expected to pay a dividenedof 1$which is expected to grow at 15% and return on working capital to be 30% after acqusition if accquistion is unsuccessful company B will be giving a return of-5% with a growth rateof-1%
what should the investor do consider the returns from 2 yrs and the present stock price of b is 2$
a. invest
do not invest
can not say
insufficient data

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Posts: 981
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foundation of risk

Postby edupristine » Wed Apr 30, 2014 8:17 am

Going from decision making tree, there are two possibilities either the acquisition is successful or it is not. So there will be 4 nodes, Invest and there is successful acquisition, invest and there is no acquisition. Then the same follows for Do not invest decision.

Then one can calculate the NPV of both all the decisions to decide on whether to invest or not

Success -0.6 In the Best case scenario too it has negative NPV
Invest 0.3

Donot Invest 0.3
Year 1 Year 2
Return 0.1 0.115
Time value 0.7 0.8
npv = -0.6 (.7+.8-2)
Since the best case scenario comes out have a negative NPV, so do not invest

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