Question
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?
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started