Analysis on risk-free rate

 

 

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. The company’s current revenue stream is $50MM with negligible costs. Let us assume that the costs are zero. If they bought the company, it would initially cost them $4MM with annual ongoing costs of $1MM.

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 makes sense for your firm to buy the company?

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