Universal Studios is considering an acquisition of the smaller German company X-Verleih AG. A due diligence report has suggested that a price of €50 million would be a reasonable price for Universal to pay for X-Verleih. Universal executives have estimated that they could generate average annual cash flows from this acquisition of €6,75 million per year over a 10 year period. At the end of the 10 years, Universal will need to make new estimates about the future prospects of the acquired company and the value of the related assets. Currently, Universal's management team is basing its calculations on the conservative assumption that the residual value of the smaller firm's assets at the end of 10 years will be zero. In order to raise the cash needed to finance this acquisition, Universal anticipates a cost of capital of 12%.
- What is the NPV of this acquisition? Should Universal proceed with or abandon its plans to acquire X-Verleih?