Question

1. Taco Bell is evaluating a project that costs $10,000,000 in a project. The project is to be financed by drawing down 6 million of the firm’s cash reserves, which is earning a risk-free return of 4%, and remaining 4 million will be raised by issuing new debt, requiring 5%. The firm’s current income statement is the following:

EBIT	6,500,000
Interest Expense (minus)	400,000
Interest Income (add)	240,000
EBT	6,340,000
Taxes (21%)	1,331,400
Net Income	5,008,600

The firm has 2 million shares outstanding. The firm has a cost of equity of 10%, and a WACC of 8%.

The project is expected to generate 650,000 in EBIT forever, and does not have any associated depreciation expenses, or NWC needs.

A. What is the Net Present Value of the Project?

B. Calculate the EPS of the firm, the EPS of the Project, and Firm + Project EPS. What impact will it have on the EPS of the firm? Is the project accretive or dilutive?

Answer 1

Required: A) Net present value of the project:
Project's cash flow per year:
Project's expected EBIT (A)	6,50,000.00
Less: Interest expenses associated (B)
(4,000,000*5%)	2,00,000.00
Earnings before tax (A) - (B) =(C )	4,50,000.00
Less: Tax at 21% (D)	94,500.00
Earnings after Tax / Cashflows from the project per year	3,55,500.00
WACC of the project:
Project cost funded by Equity	60,00,000.00
Project cost funded by Debt	40,00,000.00
Cost of equity	10%
Cost of debt	5%
WACC	(6000000*10%)+(4000000*5%)
	(6000000+4000000)
WACC of the project	8.00%
Since the cashflows expected to be generated forever (perpetual), the
Present value of future cash inflows = Expected cash inflows per year / discount rate(Wacc)
	3,55,500.00
	8%
	44,43,750.00
Total initial outflow (debt 4million +equity reserves 6 million)	1,00,00,000.00
Net present value = PV of cash inflows - PV of cash outflows	44,43,750 - 100,00,000
	-55,56,250.00
B) EPS of the firm:
EBIT	65,00,000
Interest Expense (minus)	4,00,000
Interest Income (add)	2,40,000
EBT	63,40,000
Taxes (21%)	13,31,400
Net Income	50,08,600
No. of shares outstanding	20,00,000.00
EPS = Earnings after tax / no. of equity shares outstanding	2.50
Firm + Project EPS:
EBIT	6500000 + 650000(new project)	71,50,000.00
Interest Expense (minus)	400000 + 200000(on account of new project - 4 million*5%)	6,00,000.00
Interest Income (add)	240000 which was earned on the cash reserves at the risk free rate (6 million *4%) will now not be earned as it is invested in the new project	-
EBT		65,50,000.00
Taxes (21%)		13,75,500.00
Net Income		51,74,500.00
EPS = Earnings after tax / no. of equity shares outstanding		2.58725
The EPS increases from 2.5 to 2.58725, implying the project is accretive