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In 1990, John Deere is looking to acquire a company specializing in developing artificial intelligence (AI) assisted agricultural machinery. A potential target is A-Eye, Inc.,

In 1990, John Deere is looking to acquire a company specializing in developing artificial intelligence (AI) assisted agricultural machinery. A potential target is A-Eye, Inc., which has two divisions, namely, Software Development and Robotics Technology. A-Eye is a private start-up firm and has no debt in its capital structure. John Deere is considering acquiring one of A-Eyes divisions. The analyst of John Deere has collected information on historical returns on the market portfolio and the relevant industries:

Market portfolio

Covariance with the market

Estimation period

Mean return ErM

Variance VarrM

Software industry CovrSW, rM

Robotics industry CovrRob, rM

19601989

0.10

0.020

0.028

0.052

a) Assume that the risk-free rate is 5%. Find the CAPM betas for the Software division and the Robotics division of A-Eye to determine the required rates of return on each division.

b) Despite the analysts estimates, the manager of John Deere has his own valuation principle: Use 15% as the discount rate for any valuation problems. Had the managers rule been applied, for which division of A-Eye, if acquired, would John Deere end up overpaying?

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