Foreign Acquisition Decision
Solve the following problem:
Florida Co. produces software. Its primary business in Boca Raton is expected to generate cash flows of $4 million at the end of each of the next 3 years, and Florida expects that it could sell this business for $10 million (after accounting for capital gains taxes) at the end of 3 years. Florida Co. also has a side business in Pompano Beach that takes the software created in Boca Raton and exports it to Europe. As long as the side business distributes this software to Europe, it is expected to generate $2 million in cash flows at the end of each of the next 3 years. This side business in Pompano Beach is separate from Florida's main business. Recently, Florida was contacted by Ryne Co., located in Europe, which specializes in distributing software throughout Europe. If Florida acquires Ryne Co., it would rely on Ryne instead of its side business to sell its software in Europe because Ryne could easily reach all of Florida Co.'s existing European customers and additional potential European customers. By acquiring Ryne, Florida would be able to sell much more software in Europe than it can sell with its side business, but it has to determine whether the acquisition would be feasible. The initial investment to acquire Ryne Co. would be $7 million. Ryne would generate 6 million euros per year in profits and would be subject to a European tax rate of 40 percent. All after-tax profits would be remitted to Florida Co. at the end of each year, and the profits would not be subject to any U.S. taxes since they were already taxed in Europe. The spot rate of the euro is $1.10, and Florida Co. believes the spot rate is a reasonable forecast of future exchange rates. Florida Co. expects that it could sell Ryne Co. at the end of 3 years for 3 million euros (after accounting for any capital gains taxes). Florida Co.'s required rate of return on the acquisition is 20 percent.
Determine the net present value of this acquisition. Should Florida Co. acquire Ryne Co.?