You work for a firm that is trying to decide whether they want to expand their operations by buying another company that caters to a different industry. The company thinks that with the resulting synergies between the two firms, there will be enough cost savings and economies of scale to make the new venture extremely profitable. Current revenues are $49MM with net income of $42MM per year. If the firm buys the target company the projected revenue stream will be $50MM. The synergies will lower operating costs to the point where they will have negligible expenses. For the purposes of this exercise only, let us assume that the costs are zero. If they bought the company, it would initially cost them $4MM with annual acquisition-related ongoing costs of $1MM. They will also inherit a contract that sets a minimum sales volume equivalent to a revenue level of $27MM per year. The president of the firm asked you to conduct an analysis. The time period that you are looking at is one year with six-month increments. The current risk-free rate is 4.00%. Your current research has shown that the standard deviation of the revenues is 55%. Does it make sense for your firm to buy the company?

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