Question
In: Finance
Consider the following project of Hand Clapper, Inc. The company is considering a four-year project to...
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Consider the following project of Hand Clapper, Inc. The company is considering a four-year project to manufacture clap-command garage door openers. This project requires an initial investment of $12.8 million that will be depreciated straight-line to zero over the project’s life. An initial investment in net working capital of $560,000 is required to support spare parts inventory; this cost is fully recoverable whenever the project ends. The company believes it can generate $10.3 million in pretax revenues with $3.8 million in total pretax operating costs. The tax rate is 25 percent and the discount rate is 9 percent. The market value of the equipment over the life of the project is as follows: |
| Year | Market Value (millions) | |||||
| 1 | $ | 10.2 | ||||
| 2 | 8.3 | |||||
| 3 | 4.5 | |||||
| 4 | 1.2 | |||||
| a. |
Assuming the company operates this project for four years, what is the NPV? (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to 2 decimal places, e.g., 1,234,567.89.) |
| b-1. | Compute the project NPV assuming the project is abandoned after one year. (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to 2 decimal places, e.g., 1,234,567.89.) |
| b-2. | Compute the project NPV assuming the project is abandoned after two years. (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to 2 decimal places, e.g., 1,234,567.89.) |
| b-3. | Compute the project NPV assuming the project is abandoned after three years. (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to 2 decimal places, e.g., 1,234,567.89.) |
Solutions
Expert Solution
a). NPV at the end of year 4 = 6,059,711.11
| Formula | Year (n) | 0 | 1 | 2 | 3 | 4 |
| Initial investment (II) | 1,28,00,000 | |||||
| Revenue ('R) | 1,03,00,000 | 1,03,00,000 | 1,03,00,000 | 1,03,00,000 | ||
| II/4 | Depreciation (D) | 32,00,000 | 32,00,000 | 32,00,000 | 32,00,000 | |
| Cost ('C) | 38,00,000 | 38,00,000 | 38,00,000 | 38,00,000 | ||
| R-D-C | EBIT | 33,00,000 | 33,00,000 | 33,00,000 | 33,00,000 | |
| 25%*EBIT | Tax @ 25% | 8,25,000 | 8,25,000 | 8,25,000 | 8,25,000 | |
| EBIT - Tax | Net income (NI) | 24,75,000 | 24,75,000 | 24,75,000 | 24,75,000 | |
| Add: depreciation | 32,00,000 | 32,00,000 | 32,00,000 | 32,00,000 | ||
| NI + D | Operating Cash Flow (OCF) | 56,75,000 | 56,75,000 | 56,75,000 | 56,75,000 | |
| NWC | (5,60,000) | 5,60,000 | ||||
| MV*(1-Tax) where MV = value at end of year 4 | After tax salvage value (SV) | 9,00,000 | ||||
| OCF + NWC + SV - II | Free Cash Flow (FCF) | (1,33,60,000) | 56,75,000 | 56,75,000 | 56,75,000 | 71,35,000 |
| 1/(1+d)^n | Discount factor @ 9% | 1.000 | 0.917 | 0.842 | 0.772 | 0.708 |
| FCF*Discount factor | PV of FCF | (1,33,60,000.00) | 52,06,422.02 | 47,76,533.96 | 43,82,141.25 | 50,54,613.88 |
| Sum of all PVs | NPV | 60,59,711.11 |
b-1). NPV if project is abandoned after 1 year = 1,580,366.97
| Formula | Year (n) | 0 | 1 |
| Initial investment (II) | 1,28,00,000 | ||
| Revenue ('R) | 1,03,00,000 | ||
| II/4 | Depreciation (D) | 32,00,000 | |
| Cost ('C) | 38,00,000 | ||
| R-D-C | EBIT | 33,00,000 | |
| 25%*EBIT | Tax @ 25% | 8,25,000 | |
| EBIT - Tax | Net income (NI) | 24,75,000 | |
| Add: depreciation | 32,00,000 | ||
| NI + D | Operating Cash Flow (OCF) | 56,75,000 | |
| NWC | (5,60,000) | 5,60,000 | |
| II - D | Book value (BV) | 96,00,000 | |
| MV - (MV-BV)*Tax where MV = value at end of year 1 | After tax salvage value (SV) | 1,00,50,000 | |
| OCF + NWC + SV - II | Free Cash Flow (FCF) | (1,33,60,000) | 1,62,85,000 |
| 1/(1+d)^n | Discount factor @ 9% | 1.000 | 0.917 |
| FCF*Discount factor | PV of FCF | (1,33,60,000.00) | 1,49,40,366.97 |
| Sum of all PVs | NPV | 15,80,366.97 | |
b-2). NPV if project is abandoned after 2 years = 3,680,442.72
| Formula | Year (n) | 0 | 1 | 2 |
| Initial investment (II) | 1,28,00,000 | |||
| Revenue ('R) | 1,03,00,000 | 1,03,00,000 | ||
| II/4 | Depreciation (D) | 32,00,000 | 32,00,000 | |
| Cost ('C) | 38,00,000 | 38,00,000 | ||
| R-D-C | EBIT | 33,00,000 | 33,00,000 | |
| 25%*EBIT | Tax @ 25% | 8,25,000 | 8,25,000 | |
| EBIT - Tax | Net income (NI) | 24,75,000 | 24,75,000 | |
| Add: depreciation | 32,00,000 | 32,00,000 | ||
| NI + D | Operating Cash Flow (OCF) | 56,75,000 | 56,75,000 | |
| NWC | (5,60,000) | 5,60,000 | ||
| II - Total depreciation | Book value (BV) | 64,00,000 | ||
| MV - (MV-BV)*Tax where MV = value at end of year 2 | After tax salvage value (SV) | 78,25,000 | ||
| OCF + NWC + SV - II | Free Cash Flow (FCF) | (1,33,60,000) | 56,75,000 | 1,40,60,000 |
| 1/(1+d)^n | Discount factor @ 9% | 1.000 | 0.917 | 0.842 |
| FCF*Discount factor | PV of FCF | (1,33,60,000.00) | 52,06,422.02 | 1,18,34,020.71 |
| Sum of all PVs | NPV | 36,80,442.72 | ||
b-3). NPV if project is abandoned after 3 yrs = 4,661,386.01
| Formula | Year (n) | 0 | 1 | 2 | 3 |
| Initial investment (II) | 1,28,00,000 | ||||
| Revenue ('R) | 1,03,00,000 | 1,03,00,000 | 1,03,00,000 | ||
| II/4 | Depreciation (D) | 32,00,000 | 32,00,000 | 32,00,000 | |
| Cost ('C) | 38,00,000 | 38,00,000 | 38,00,000 | ||
| R-D-C | EBIT | 33,00,000 | 33,00,000 | 33,00,000 | |
| 25%*EBIT | Tax @ 25% | 8,25,000 | 8,25,000 | 8,25,000 | |
| EBIT - Tax | Net income (NI) | 24,75,000 | 24,75,000 | 24,75,000 | |
| Add: depreciation | 32,00,000 | 32,00,000 | 32,00,000 | ||
| NI + D | Operating Cash Flow (OCF) | 56,75,000 | 56,75,000 | 56,75,000 | |
| NWC | (5,60,000) | 5,60,000 | |||
| II - Total depreciation | Book value (BV) | 32,00,000 | |||
| MV - (MV-BV)*Tax where MV = value at end of year 3 | After tax salvage value (SV) | 41,75,000 | |||
| OCF + NWC + SV - II | Free Cash Flow (FCF) | (1,33,60,000) | 56,75,000 | 56,75,000 | 1,04,10,000 |
| 1/(1+d)^n | Discount factor @ 9% | 1.000 | 0.917 | 0.842 | 0.772 |
| FCF*Discount factor | PV of FCF | (1,33,60,000.00) | 52,06,422.02 | 47,76,533.96 | 80,38,430.03 |
| Sum of all PVs | NPV | 46,61,386.01 | |||
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