Assess the likelihood that the following firms will be taken over, based upon yo
ID: 2716277 • Letter: A
Question
Assess the likelihood that the following firms will be taken over, based upon your understanding of the free cash flow hypothesis.
a. A firm with high growth prospects, good projects, low leverage, and high earnings.
b. A firm with low growth prospects, poor projects, low leverage, and poor earnings.
c. A firm with high growth prospects, good projects, high leverage, and low earnings.
d. A firm with low growth prospects, poor projects, high leverage, and good earnings.
e. A firm with low growth prospects, poor projects, low leverage, and good earnings. You may use a scale ranging from Low to Moderate to High to Highest in providing your assessment
Explanation / Answer
a. A firm with high growth prospects, good projects, low leverage, and high earnings. Since the leverage is low, with high growth prospects, good projects and high earnings, it has the highest likelihood of being taken over. The free cash flow of the firm should be sufficient to cover its immediate liabilities. b. A firm with low growth prospects, poor projects, low leverage, and poor earnings has a extremely low likelihood of being taken over. The position of the firm is such that even if it has a free cash flow, the same will not be sufficient to meet its immediate liabilities, thus leaving a further debt position for long term liabilities. c. A firm with high growth prospects, good projects, high leverage, and low earnings will have a moderate high of being taken over. Since its earnings are low, the free cash flow balance will be affected, and it is unlikely that the current liabilities will be met thereagainst. d. A firm with low growth prospects, poor projects, high leverage, and good earnings will have a moderate likelihood of being taken over. Although it has a high leverage, there will be only a sufficient free cash flow to meet up with its immediate liabilities. e. A firm with low growth prospects, poor projects, low leverage, and good earnings will have a moderate likelihood of being taken over. Reasons for the same will be as given in d above.