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ACCA Strategic Professional · Advanced Financial Management · Acquisitions and mergers versus other growth strategies

Brelmont Ltd needs a new product capability. Building it organically costs 40m now and generates net cash flows of 14m a year for 4 years, then nothing. Acquiring Carvex, which has the capability, would cost 55m now and generate 20m a year for 4 years. Brelmont's cost of capital is 10%. The 4-year annuity factor at 10% is 3.170. Which option has the higher NPV, and what is it?

The acquisition has the higher NPV. Organic growth gives 14m x 3.170 less 40m, which is 4.38m. Acquisition gives 20m x 3.170 less 55m, which is 8.40m. On NPV alone the acquisition adds more value.

  1. AOrganic: NPV 4.38m, which is higher than acquisition NPV of 8.40m
  2. BAcquisition: NPV 8.40m, higher than organic NPV of 4.38mCorrect
  3. CAcquisition: NPV 15.00m, higher than organic NPV of 4.38m
  4. DOrganic: NPV 4.38m, higher than acquisition NPV of 3.40m

Explanation

Organic NPV = 14 x 3.170 - 40 = 44.38 - 40 = 4.38m. Acquisition NPV = 20 x 3.170 - 55 = 63.40 - 55 = 8.40m. Acquisition is higher. Option 1 contradicts itself, since it labels organic as higher although 4.38m is below 8.40m.

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