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I need help with this homework problem for my finance class. Please tell me how to solve this!!!?

Meds International (MI) is evaluating the purchase of Focused Pharmaceuticals (FP), a firm that is developing targeted treatments for various forms of cancer. As an analyst at MI you have been charged with using a discounted cash flow analysis to figure out what FP is worth to MI. Last year FP had revenues of $100 million, operating costs (including R&D) were 75 % of revenues, and depreciation expenses were $9 million. The firm has a beta of 1.25, the risk-free rate of return is 4%, and the market risk-premium is 5.5%. FP uses very little debt financing, and debt constitutes 15% of total financing. The yield to maturity on the firm's debt is 6%, and the tax rate is 34%.

If purchased by MI, revenues are expected to grow at a rate of 20% per year for the next 5 years. Operating costs should be 70% of revenues for the next 3 years, and 65% of revenues beyond that. Capital expenditures are expected to remain steady at $15 million per year over the next 5 years, and result in annual increases in depreciation of $3 million. FP's net working capital is currently $10 million, and the firm maintains a ratio of net working capital to revenues of 0.10.

If cash flows from operations are expected to increase at a rate of 4% per annum after the next 5 years, what is the maximum amount that MI should be willing to pay for FP?

1 Answer

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  • 1 decade ago
    Favorite Answer

    $0.00 - MI should form a new entity (WXY Corp), loan it $3,000,000,000 secured by WXY stock; WXY buys FP (price no object); use FP revenues to make payments to MI for the paper debt od WXY; show staggering growth for MI investments; wait for federal prosecutors and angry investors.

    Source(s): Ken Lay/Enron
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