Question

Prepare a pro-forma statement by using assumptions to calculate the annual operating net cash flow for three years to calculate the the NPV and IRR.

Assess project feasibility using NPV and IRR method.

Company is Z-energy

For the data part you can refer to the Yahoo finance or assume any relevant data according to the company

Answer 1

Assume, an asset purchased for $150,000 with an interest rate of 10% p.a. The life of the asset is 3 years. Cost of capital of the company is 10%. Tax rate would be 30%. Asset generates an income of $70,000, $95,000, and $140,000 in year 1, year 2, and year 3 respectively.

Depreciation per year = asset value/ no. of years of useful life

= $150,000/ 3 = $50,000

Therefore, Depreciation per year = $50,000

Interest to be paid per year = asset value * 10% = $150,000 * 10% = $15,000

Interest to be paid per year = $15,000

EBITD (Earnings before interest, tax, and depreciation) for the year 1 = $70,000EBITD for the year 2 = $95,000

EBITD for the year 3 = $140,000

Calculation of Annual Operating Net Cash Flow for Three Years:

	Year 1	Year 2	Year 3
EBITD	70,000	95,000	140,000
Less: Depreciation	(50,000)	(50,000)	(50,000)
EBIT	20,000	45,000	90,000
Interest	(15,000)	(15,000)	(15,000)
EBT	5,000	30,000	75,000
Tax on EBT @ 30%	(1,500)	(9,000)	(22,500)
EAT	3,500	21,000	52,500
Add: Depreciation	50,000	50,000	50,000
AONCF	53,500	71,000	102,500

Here, depreciation is added back to calculate AONCF as it is a non-cash expenditure.

Note:

EBITD = Earnings before interest, tax, and depreciation

EBIT =  Earnings before interest and tax

EBT = Earnings before tax

EAT = Earnings after tax

AONCF = Annual operating net cash flow

Calculation of NPV at 10% (Cost of Capital):

Cost of capital = r = 10% = 0.1

Present value factor (PVF) for year 1 = 1/ (1 + r )¹ = 1/ (1 + 0.1 )¹ = 0.909

PVF for year 2 = 1/ (1 + 0.1 )² = 0.826

PVF for year 3 = 1/ (1 + 0.1 )³ = 0.751

Year	AONCF	PVF @ 10%	Present Value
0	-150,000	0	-150,000
1	53,500	0.909	48,636
2	71,000	0.826	58,678
3	102,500	0.751	77,010
NPV			34,324

Calculation of NPV at 25% to Calculate IRR:

Cost of capital = r = 25% = 0.25

Present value factor (PVF) for year 1 = 1/ (1 + r )¹ = 1/ (1 + 0.25 )¹ = 0.800

PVF for year 2 = 1/ (1 + 0.25 )² = 0.640

PVF for year 3 = 1/ (1 + 0.25 )³ = 0.512

Year	AONCF	PVF @ 25%	Present Value
0	-150,000	0	-150,000
1	53,500	0.800	42,800
2	71,000	0.640	45,440
3	102,500	0.512	52,480
NPV			-9,280

Calculation of IRR:

IRR can be calculated with the below formula,

IRR = LR + ( (NPV at LR / (NPV at LR - NPV at HR )) * DR )

LR = Lower interest rate = 10%

HR = Higher interest rate = 25%

NPV at LR = NPV at 10% = $34,324

NPV at HR = NPV at 25% = -$9,280

DR = Difference in interest rates = 25% - 10% = 15%

Therefore, DR = 15%

IRR = 10% + ( (34,324 / (34,324 - ( - 9,280) )) * 15% )

= 10% + ( (34,324 / (34,324 + 9,280 )) * 15%)

= 10% + ( (34,324 / 43,604) * 15%)

= 10% + (0.787 * 15%)

= 10% + 11.8%

IRR = 21.8%