You are the General Manager at the Bicker, Slaughter, and Lynch Law Firm. There is an opportunity to buy out a small law firm that was just started by a young MBA/JD, and you believe the firm can be grown and become a lucrative part of your Firm.
With help from your finance leader, you have estimated the following benefit streams for this new division:
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Year 1
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Year 2
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Year 3
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Year 4
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Year 5
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Year 6
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Year 7
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Year 8
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Before Tax Cash Flow From Operations
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$(149,000)
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$0
|
$51,380
|
$88,760
|
$114,100
|
$129,780
|
$143,640
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$167,300
|
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After Tax Net Income From Operations
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$(103,500)
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$(50,500)
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$36,700
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$63,400
|
$81,500
|
$92,700
|
$102,600
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$119,500
|
|
After Tax Cash Flow From Operations
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$(85,600)
|
$15,000
|
$48,600
|
$72,200
|
$95,550
|
$101,300
|
$125,200
|
$140,200
|
|
|
|
|
|
|
|
|
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You estimate that the purchase price for this firm would be $200,000 and that additional net working capital would be needed in the amount of $60,000 in year 0, an additional $20,000 in year 2 and then $20,000 in year 5.
BSL usually spend about $275,000 per year in advertising. If you make this acquisition, you would ask that advertising spending be increased by an incremental one-time amount of $50,000 in year 0 to publicize the firm's expansion.
Your finance leader has indicated that the firm has access to a credit line and could borrow the funds at a rate of 6%. He also mentions that when he runs project economics for capital budgeting (such as a new copier or a company car), he recommends a standard 10% rate discount, but the one other time they looked at an acquisition of a smaller firm, he used a 12% rate discount. Obviously you will want to select the most appropriate discount rate for this type of project.
At the end of 8 years, the plan will be to sell this division. The estimated terminal value (the sale and the return of working capital) is conservatively estimated to be $300,000 of after-tax cash flow help.
Using the data that you need (and ignoring the extraneous information), calculate the Nominal Payback, the Discounted Payback, the Net Present Value, and the IRR for this potential acquisition.
Discussion - in a Word Document in paragraph form, respond to the following:
1) From a purely financial (numbers) perspective, would you recommend this purchase to management? Why?
2) What are some of the non-financial elements that need to be considered for this proposal?
3) Assumptions in project economics can have a huge impact on the result. Identify 3 financial elements/assumptions in your analysis that would make this project not be financially attractive(e.g., answer this question: what would have to be true for this to be a bad investment?).
4) If you were the CEO, would you approve this proposal? Why or why not?