Briefly describe the three value-increasing reasons for a firm to consider a merger or an acquisition.

Leveraged buyouts (LBOs) are acquisitions financed with debt. Targets for LBOs tend to be profitable companies in mature industries with limited investment opportunities. Explain how this is consistent with a value-increasing strategy.

List at least two ways capital budgeting analysis is improved by noting the importance of managerial options.

Use the following information to answer Questions 4 and 5.

Suppose you are offered the following investment opportunity. For an initial outlay of $1,400, you will receive a contingent claim to a perpetuity, beginning in one period, equal to either $100 or $300. The outcomes are equally likely. Thus, you pay $1,400 up front and at the end of the period a coin is tossed to establish whether you will receive $100 or $300 in perpetuity.

What is the expected NPV of the investment if we use a discount rate of 10%? Suppose you can postpone the investment until the level of the perpetuity is revealed. You have the option to wait until the end of the period when the perpetuity is revealed to be either $100 or $300 and at that point in time you can decide whether to invest $1,400 to receive the perpetuity beginning one period later. What is the expected NPV of the investment with the real option to postpone the decision?

Suppose we change the previous problem so the risk of the contingent claim decreases and the range of the perpetuity value falls. There is now an equal chance that the perpetuity will be either $125 or $275. Assuming the discount rate is now 8%, what is the expected NPV of the investment if the decision must be made now? What is the expected NPV of the investment if the real option exists to postpone the decision until the value of the perpetuity is revealed?