A project, an acquisition and an expansion choice

A corporation has 110 of usable capital today and must choose among a project P, acquisition A and an expansion that can be reserved as right O or committed to now as K. O and K are alternative strategies for the same expansion. The question is incremental value to this buyer, in one currency at date 0, against continuing the existing activities without these additions. All amounts below use consistent after-tax claims and include their relevant costs. The project, acquired business and expansion use different operating resources; absent a stated constraint their cash effects are additive. This is FIN.1’s financial frame.

For P, use one tenth of FIN.6’s constructed project. Equipment 90 and working capital 10 require 100 now. An operating projection prepared through FIN.4 supplies annual sales 110 and cash operating costs 40; FIN.6 then subtracts displaced contribution 6 and feasible rent forgone 4, giving margin 60. With depreciation 45 and same-year usable tax at 25%, operating cash is (60−45)×0.75 + 45 = 56.25. Year 2 adds working-capital recovery 10, asset sale after tax 7.5 and closure after tax −1.5, giving 72.25. A qualified supplied return of 10% fits these operating flows; use FIN.5’s construction if that basis must be obtained. NPV is −100 + 56.25/1.1 + 72.25/1.1² = 10.85.

For A, use FIN.7’s zero-growth operating value 100: 10/1.1 + (10+100)/1.1². Subtract the debt of 30 remaining in the acquired company and add included excess cash 10 to obtain equity value 80. Buyer benefits produce incremental after-tax cash 16.5 and 18.15 in years 1 and 2, with supported return 10%; their present value is 30. Integration costs 15 are paid today. At equity price 90, buyer NPV is 80 + 30 − 15 − 90 = 5. Both price and integration payment fall due before closing; the acquired 10 becomes usable only afterward.

For O, use FIN.8’s fee-8 strategy: pay 8 today, then pay 60 in one year only if the revealed expansion value is 90 rather than 40. Its probability 0.5 and stipulated absence of priced risk before exercise support discounting the 30-or-zero payoff at 5%, giving NPV 6.29. This rate differs from P’s because the risk grounds differ. A pre-existing deposit, unavailable today, releases 60 just before that exercise date; its receipt is in the baseline cash plan for every alternative. Exercising consumes that money, already included as the 60 exercise cost, so the deposit is not added again to O’s value. The available fixed strategy K also pays 60 at that date but must do so in both states. Its NPV is (0.5×30 + 0.5×(−20))/1.05 = 4.76 and it requires no payment today.

Every combination containing both P and A exceeds 110; O and K cannot be selected together. The reservation fee is due before the acquired cash is released, so that cash cannot rescue A+O at the required time. With the stated independent effects and later exercise funding, P+O leads. The full cash plan must also support P’s intervening payments; that feasibility is a supplied condition of this case, not inferred from expected NPV.

Now suppose obtainable rent for P’s resource rises from 4 to 15 per year, leaving the acquisition and both expansion strategies unchanged. P’s flows become −100,+48,+64 and NPV −3.47. P+O remains affordable but falls to 2.81; P+K falls to 1.29. A+K at 9.76 now leads, exceeding O alone at 6.29. The changed recommendation follows the baseline through the cash construction into the whole comparison. If the deposit’s release is delayed, funding for O or the binding K payment must be recovered through FIN.2 and any changed financing effect valued before relying on either recommendation.