Valuation of an Acquisition Using Real Options
0
Valuation
of an Acquisition Using Real Options
Intel is
considering the purchase of Hannover-Ceramics, Inc., a firm that has just
patented a replacement for the silicon wafer, the arsenicon-dithurate
wafer. As a result, Intel estimates that
it will be able to manufacture a new generation of processor, with speeds
upwards of 250 gigabytes. However, the
current production method calls for the use of amenocebic acid, a naturally
occurring substance with a cost of $200
per ounce. Each wafer requires, on average,
4 ounces of the acid to produce. Due to
this limitation, the economic feasibility of this investment remains unclear.
Intel
engineers have invested $400 million and over 4000 work-hours over the past two
years to develop a less expensive substitute for amenocebic acid. They have a potential substitute known as
Carlinium, named in honor of the inventor.
This substance, while far less expensive to produce ($50/ounce), requires
3 ounces to produce one wafer. More
importantly, there is evidence that Carlinium is a very carcinogenic substance
and may be banned by the EPA. There is
currently a study underway to investigate whether Carlinium is, in fact,
dangerous. Preliminary evidence suggests
there is a 1 in 3 chance that Carlinium is poisonous, though the final results
of the tests will not be known for 12 months.
If Carlinium is proven to cause cancer, Intel will be forced to use the
more expensive amenocebic acid for production and to price the chips
accordingly. As a result of the higher
price of the chips, demand is expected to be far less.
Intel
will need to build a production facility regardless of the process they use
(amenocebic or Carlinium). The cost of
this plant will be $450 million and will require one year to come online. Intel already owns the land where the new
facility can reside. Assume that the
land has no opportunity cost. You will
depreciate this investment using straight-line depreciation over 10 years. After 10 years of production, you anticipate
that the next generation of processor material will have made
arsenicon-dithurate obsolete and the production facility valueless.
Intel,
however, is not in a position that they can wait until the safety of Carlinium
is known to decide whether to purchase Hannover-Ceramics. Motorola, a prime competitor of Intel, has
been rumored to be nearing completion of their own substitute for amenocebic
acid and may try to acquire Hannover-Ceramics before the end of the year.
There
are three public firms in the same industry as Hannover-Ceramics, and all four
firms are exclusively equity financed.
The following table reports the current stock prices, 52-week highs and
lows, and standard deviation of returns over the past 10 months:
Firm
|
Current
Price
|
52-week
High
|
52-week
Low
|
Standard
Deviation
|
bequity
|
Hannover-Ceramics
Inc.
|
Private
Firm
|
||||
Computer
Internal Inc.
|
$75.25
|
$125.00
|
$75.25
|
30%
|
1.65
|
New
Age Materials Corp.
|
$23.45
|
$26.13
|
$22.63
|
22%
|
1.7
|
Dyne-Ceramic
|
$54.88
|
$110.08
|
$17.25
|
44%
|
2.1
|
Current
market returns are averaging 10% and the risk-free interest rate is 4%.
The incremental
number of units sold per year and price per unit are detailed in Table 2 under
two different scenarios (using Carlinium or Amenocebic acid). In addition to the price of Carlinium or
amenocebic acid, each chip requires an average labor cost of $15 and $25 in
other expenses to produce. Assume that
there is no require working capital for this project and that the corporate tax
rate is 35%.
Table 2
|
Carlinium
Acid
|
Amenocebic
Acid
|
|||
Year
|
Millions
of chips
|
Price/Chip
($)
|
Thousands
of chips
|
Price/Chip
($)
|
|
1
|
2.5
|
500
|
200
|
1,400
|
|
2
|
3
|
500
|
150
|
1,200
|
|
3
|
3
|
450
|
75
|
1,100
|
|
4
|
4.5
|
425
|
75
|
1,050
|
|
5
|
4
|
350
|
65
|
1,050
|
|
6
|
4.5
|
300
|
65
|
1,050
|
|
7
|
4.5
|
250
|
50
|
950
|
|
8
|
4.5
|
250
|
50
|
950
|
|
9
|
3.5
|
250
|
35
|
875
|
|
10
|
2
|
250
|
30
|
875
|
|
Question #1: What is the NPV of this
project?
Question #2: What is the value of the
option? (Net of the NPV).
Question #3: Should Intel attempt to
purchase Hannover-Ceramics and, if so, what is the maximum price that can be
paid?
Your analysis should be summarized in the
form of a 1-2 page executive summary, with attached appendixes. DO NOT be cavalier or “cute” in your
write-up; write as professional of a document as you are able.
You should briefly state any assumptions
that you make in your analysis.
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