Finance

Hello. This is kind of long, but I would truly appreciate it if someone could help me validate my solutions for the three questions listed below. Thank you in advance.

A firm is considering acquiring a new segment to add to its product line. The estimated sales growth rate is 6.75% and the firm forecasts to sell 3000 units of its new product, which is priced at 37.50 per unit. COGS is estimated at 48% of current years sales.

The expansion will need an investment of $90,000 in new equipment, which will be depreciated at $25,000/year over three years. Net working capital is estimated to be 20% of sales per year.

The firm also builds up initial inventory of 10% of the first year’s anticipated COGS before beginning the project. The firm’s tax rate is 30% and the firm’s WACC is 10.5%. The equipment will be sold at the end of three years for $10,000.

Questions

1. What are project free cash flows per year?
2. What is the terminal value?
3. What is the NPV and IRR for this project? Should you accept it?

My Calculations

Sales (3000 unites at 37.50 per unit) = $112,500

COGS (112,500 x 0.48) = $54,000

$58,500

Depreciation (25,000 / 3) = $8,333

EBIT = $50,167

Taxes (30%) = $15,050.10

NOPAT (Net Income) = $35,116.90

Change in NWC = 0.20 x 112,500 = $22,500

CAPEX = $90,000

Operating Cash Flow = EBIT + Depreciation - Taxes

= 50,167 + 8333 - 15,050.10

= $43,449.90

Sale Price - Taxes = 112,500 - 15,050.10 = $97,449.90

FCF in terminal year = 35,116.90 + 8333 - 22,500 - 90,000 = -$69,050

FCF in terminal year x (1 + Gss) = -69,050 x (1 + 0.0675) = -$73,710.88

TV in steady state = -73,710.88 / (0.105 - 0.0675) = $1,965,623.47

$1,965,623.47+ (-69,050) =$1,896,573.47

NPV = Enterprise Value = $1,286,628.72

Accept project

  1. 👍 0
  2. 👎 0
  3. 👁 250
  1. You seem to have deducted machine depreciation as 25000/3 instead of 25000/year.
    Also, you have provided the first year cash flow without taking into account of the WACC.

    I suggest you make a cash-flow diagram for three years, using following information (if you agree with it, if not, make modifications) as follows:

    Positive cash-flows:
    ===================
    Sales (increases by 6.5% annually)
    Y(0)=0
    Y(1)=112500
    Y(2)=119812.50
    Y(3)=127600.31
    Salvage of equipment
    Y(3)=10000
    Recovery of 10% COGS
    Y(3)=6124.82 (10% of COGS for year 3)
    Recover of NWC
    Y(3)=25520.06 (20% of sales)

    Negative cash-flows (negative signs omitted)
    ===================
    Inventory
    Y(0)=5400 (10% COGS)
    Y(1)=731.25 (additional due to increase in sales)
    Y(2)=778.78 (additional amount due to increase in sales)
    NWC
    Y(0)=22500 (20% of expected sales)
    Y(1)=731.25 (due to additional sales)
    Y(2)=778.78 (due to additional sales)
    Taxes
    Y(0)=0
    Y(1)=8700 (30% of Sales-COGS less machine depreciation of 25000)
    Y(2)=9753
    Y(3)=10874.45

    Net Cash-flow / NPV
    ===================
    Y(0)=-117900 / -117900
    Y(1)=49068.75 / 44406.11
    Y(2)=51770.72 / 42399.39
    Y(3)=97122.59 / 62526.33

    So NPV=31431.82
    IRR=(31431.82/117900)^(1/3)=0.082 or 8.2%

    So if IRR of 8.2% is acceptable for the entreprise, then go ahead.

    I am not sure how to proceed with terminal value, because machines may cost more after three years, and sales may or may not remain at a growth of 6.5%, WACC may change....etc.

    1. 👍 0
    2. 👎 0
  2. Oh yes, please add machine cost Y(0)=90000 to negative cash-flows. All other calculations remain valid.

    1. 👍 0
    2. 👎 0

Respond to this Question

First Name

Your Response

Similar Questions

  1. Check my work

    Jennifer is very social and outgoing. She doesn’t like to sit for long periods of time and she dislikes work that requires her to stay at her desk. Variety keeps her motivated. For which kind of job would she be most suited?

  2. math

    lyle needs 200g of chocolate that is 86% cocoa for a cake recipe he has one kind that is 99% cocoa and another kind that is 70% cocoa. How much of each kind does he need to make the cake

  3. US History

    After some dude named Columbus bumps into the American continents, thousands and thousands of people decide, "Hey, why not get on a rickety boat and risk drowning in a storm or dying of scurvy, just so long as there is a new

  4. science

    An electron micrograph of a newly discovered cell shows long projections with a basal body in the cell wall. What kind of projections are these? Is the cell prokaryotic or eukaryotic? How might this cell behave in its environment

  1. ELA

    Which sentence contains both an adverb and a conjunction? A. Do you want the shrimp or the crab? B. Don't imagine you can't do as you wish. C. Lawson crept silently up the stairs, but couldn't still his heartbeat. D. Lucille was a

  2. Math 1100

    A pipe 24ft long is cut into four pieces, the first 4ft long, the second 5ft long, and the third 7ft long. What is the length of the remaining piece ?

  3. Math

    a kind benefactor sets up a prize in an international school. the benefactor donates $10 000. the school invests the money in an account paying 5% interest. if $750 was paid out annually, for how long can the full prize be given

  4. English

    What's your personality? What are you like? 1. I'm kind of introverted. 2. I'm kind of introvert. 3. I'm kind of introvertish. 4. I'm kind of extroverted. 5. I'm kind of extrovert. ----------------- Are the answers all

  1. Math 117

    How is dividing a polynomial by a binomial similar to or different from the long division you learned in elementary school? Can understanding how to do one kind of division help you with understanding the other kind? What are some

  2. English

    Can you tell me if the following sentences or phrases are possible? Thank you very much in advance. 1) I'm wearing a pair of blackt trainers withe the logo Nike on them, 2) Did you have to work this weekend? 3) I usually wear

  3. math

    Sandra needs 2 3/4 cups of flour for one kind of cookie and 3 3/8 cups for another kind. How much would she need for both kinds?

  4. english

    "There's four kinds of folks in the world. There's the ordinary kind, like us and the neighbours, there's the kind like the Cunningham's out in the woods, the kind like the Ewell's down at the dump, and the Negroes." what

You can view more similar questions or ask a new question.