A company raises €500m in shareholders' equity for an R&D project. Has it become richer or poorer? By how much? What is your answer if the company spends half of the funds in the first two years, and the project does not produce results? In the third year, the company uses the remaining funds to acquire a competitor that is overvalued by 25%. But thanks to synergies with this new subsidiary, it is able to improve its earnings by €75m. Has it become richer or poorer? By how much?

 

Answer:

1: The company has only attained the status of being richer through raising more equity. The idea is founded on the available funds for use which in total amounts to €500 m

2: The company has attained the status of being poorer by €250 m simply because the company has expended the said amount without gain or profit.

3: The company spent €250 m in the 3rd year and received assets worth €187.50 m (€250m * 75%), and improved earnings by €75 m. The summation or total return is therefore €262.50 m (€187.50 m + €75 m). When compared to the initial investment of €250 m, the company has successfully gained or profited by €12.50 m, that is (€262.50 - €250). So the company has become richer by €12.50