Question

Dhingra & Associates Consulting and our firm is working on behalf of Falguni and Sameer’s Financial Empire. The Empire is involved in a major capital expansion by developing a significant Entertainment Centre.

An in- depth market survey and a concept plan have been completed by Dhingra and Associates at a considerable cost of $375,000.

Falguni has owned the land for years and the book value (balance sheet) is just $500,000, and its current market value is $4 million (4,000,000). If the Entertainment Centre project is evaluated over a 10-year period and when the Centre is shut down at the end of that period, the land would be worth $4.8 million based on a land appreciation rate of about 2% per year on average. The project requires a large castle structure, costing $18 million, to be constructed this year (year 0). The castle is a Class 1 asset with a CCA rate of 4%. At the end of the 10-year period, we estimate that the castle can be sold for about half of its initial cost.

We estimate that an investment of $7 million is required for equipment needed to operate the new Centre. This capital cost for all equipment will be depreciated using straight-line depreciation over the 10-year period (starting from year 1)1. Of course, the equipment required for the Centre will be treated quite roughly during this period, so we estimate that they will have no value at the end of the project’s life. All annual depreciation amounts related to both the castle and the equipment will result in an annual tax-shield for the company, but we’re not sure how to account for this in our project analysis. Falguni and Sameer have instructed us that they require a 10% rate of return on this type of project based on similar risk projects. They have sufficient capital available and the marginal tax rate for their company is 35%.

NOTE: 1 Straight-line depreciation means that the annual depreciation amount allowed under CCA tax rule is simply the total initial cost divided by number of years in the project’s life.

The project requires $1.2 million in incremental net working capital (NWC) immediately (at year 0). The required amount will double at the end of year 1, and then we expect that it will need to be maintained at the level of $3 million starting from the end of year 2 (when the Centre is working at full capacity) until the end of the project. Please note that at the end of the 10th year, the accumulated NWC will no longer be required.

We estimate that the Entertainment Centre will have $1 million in extra annual fixed costs for the company. Based on our marketing research, we estimate the incremental revenue in year 1 to be about $12 million, with incremental variable costs of $6 million. For each of years 2 to 7, the Centre will run at full capacity, with annual incremental revenues of $15 million and annual incremental variable costs of $7 million for the company. For the last three years (years 8-to-10), we expect a gradual slowdown in the Centre’s activities that will result in about $1 million of lost revenues per year. This will be accompanied by a $0.5 million reduction in variable costs. There will be no change in the fixed costs of operating the Centre over the 10-year period (from year 1-to-10).

Please use (display + name) the excel function/ formula used for cells (as required).

Ques 1: Given the above information, what is the NPV of this Entertainment Centre project?

Ans: Computing the NPV of the Entertainment Centre project assuming a RRR of 10%

Building:			Equipment:
Initial Cost
Salvage value
Tax Rate
CCA Rate
Discount Rate	10.00%
Number of periods
			PV(CCA TS equipment)
PV( CCA TS building)	$???	this cell will calculate the PV of the CCA tax-shield on the building after you enter all relevant information needed.

Cash flows from Assets:
Year	Revenues	Costs (Fixed+Variable)	(Rev-Cos) after tax	Additions to NWC	Net Capital Spending		Total Net CF of project
0
1
2
3
4
5
6
7
8
9
10

Ques 2 :Using the base case, what is the percentage change in the project’s NPV if the required return increased by 2% (r =12% instead of 10%) to account for additional risk factors?

Total project NPV
Base scenario - NPV @ 10%
Q 2:             NPV @12%
Q 2:   Chge in NPV:

Ques 3 : What is the NPV in a scenario where the annual incremental costs (both fixed and variable) and annual incremental revenues are all worse by 5% compared to the base scenario?

Ans 3: NPV under a scenario where revenues and costs are worse by 5%
Year	Revenues	Costs (Fixed+Variable)	(Rev-Cos) after tax	Additions to NWC	Net Capital Spending		Total Net CF of project
0
1
2
3
4
5
6
7
8
9
10

Total project NPV under this new scenario
NPV @ 10%
change in NPV:		compared to base scenario (Q1)

Answer 1

1) on the above given information the NPV of the entertainment project is $ -5248182.96.

A/1	B	c	D	E	F	G	H	i	J	K	L	M
2	Particulars	1	2	3	4	5	6	7	8	9	10
3	Annual Revenue	12000000	15000000	15000000	15000000	15000000	15000000	15000000	14000000	14000000	14000000
4	Less: variable cost	6000000	7000000	7000000	7000000	7000000	7000000	7000000	6500000	6500000	6500000
5	Contibution	6000000	8000000	8000000	8000000	8000000	8000000	8000000	7500000	7500000	7500000
6	Less:Fixed cost	1000000	1000000	1000000	1000000	1000000	1000000	1000000	1000000	1000000	1000000
7		5000000	7000000	7000000	7000000	7000000	7000000	7000000	6500000	6500000	6500000
8	Depreciation	720000	720000	720000	720000	720000	720000	720000	720000	720000	720000
9		18000000*4%
10		700000	700000	700000	700000	700000	700000	700000	700000	700000	700000
11		7000000/10
12	Earning before tax	3580000	5580000	5580000	5580000	5580000	5580000	5580000	5080000	5080000	5080000
13		C7-(C8+C10)
14	Less: tax(35%)	1253000	1953000	1953000	1953000	1953000	1953000	1953000	1778000	1778000	1778000
15	Earning after tax	2327000	3627000	3627000	3627000	3627000	3627000	3627000	3302000	3302000	3302000
16	Add:Depeciation	1420000	1420000	1420000	1420000	1420000	1420000	1420000	1420000	1420000	1420000
17	Cash flow from the operation	3747000	5047000	5047000	5047000	5047000	5047000	5047000	4722000	4722000	4722000
18	Less: change in working capital	2400000	3000000	3000000	3000000	3000000	3000000	3000000	3000000	3000000	3000000
19		1347000	2047000	2047000	2047000	2047000	2047000	2047000	1722000	1722000	1722000
20	Discounted value	1224545.455	1691735.537	1537941.397	1398128.543	1271025.948	1155478.135	1050434.668	803325.7087	730296.0988	663905.5444
21	total value	C19/(1.1)^1									11526817.04	sum(C20:L20)
22	Increase in the value of land										800000
23	scrap value of castle										9000000
24											21326817.04
25											sum(L21:L23)
26	Initial cost
27	0 year working capital	1200000
28	Market survey cost	375000
29	castle construction	18000000
30	Equipment cost	7000000
31		26575000
32
33	NPV	-5248182.965
34
35

b)If Rate is 12% then NPV is -6741526.345

A/1	B	c	D	E	F	G	H	i	J	K	L	M
2	Particulars	1	2	3	4	5	6	7	8	9	10
3	Annual Revenue	12000000	15000000	15000000	15000000	15000000	15000000	15000000	14000000	14000000	14000000
4	Less: variable cost	6000000	7000000	7000000	7000000	7000000	7000000	7000000	6500000	6500000	6500000
5	Contibution	6000000	8000000	8000000	8000000	8000000	8000000	8000000	7500000	7500000	7500000
6	Less:Fixed cost	1000000	1000000	1000000	1000000	1000000	1000000	1000000	1000000	1000000	1000000
7		5000000	7000000	7000000	7000000	7000000	7000000	7000000	6500000	6500000	6500000
8	Depreciation	720000	720000	720000	720000	720000	720000	720000	720000	720000	720000
9		18000000*4%
10		700000	700000	700000	700000	700000	700000	700000	700000	700000	700000
11		7000000/10
12	Earning before tax	3580000	5580000	5580000	5580000	5580000	5580000	5580000	5080000	5080000	5080000
13		C7-(C8+C10)
14	Less: tax(35%)	1253000	1953000	1953000	1953000	1953000	1953000	1953000	1778000	1778000	1778000
15	Earning after tax	2327000	3627000	3627000	3627000	3627000	3627000	3627000	3302000	3302000	3302000
16	Add:Depeciation	1420000	1420000	1420000	1420000	1420000	1420000	1420000	1420000	1420000	1420000
17	Cash flow from the operation	3747000	5047000	5047000	5047000	5047000	5047000	5047000	4722000	4722000	4722000
18	Less: change in working capital	2400000	3000000	3000000	3000000	3000000	3000000	3000000	3000000	3000000	3000000
19		1347000	2047000	2047000	2047000	2047000	2047000	2047000	1722000	1722000	1722000
20	Discounted value	1202678.571	1631855.867	1457014.167	1300905.506	1161522.774	1037073.905	925958.8438	695486.9186	620970.463	6.638204898
21	total value	C19/(1.12)^1									10033473.65	sum(C20:L20)
22	Increase in the value of land										800000
23	scrap value of castle										9000000
24											19833473.65
25											sum(L21:L23)
26	Initial cost
27	0 year working capital	1200000
28	Market survey cost	375000
29	castle construction	18000000
30	Equipment cost	7000000
31		26575000
32
33	NPV	-6741526.345

c) if revenue and cost is reduced 5 % the the NPV is $ -7883245.258

A/1	B	c	D	E	F	G	H	i	J	K	L	M
2	Particulars	1	2	3	4	5	6	7	8	9	10
3	Annual Revenue	11400000	14250000	14250000	14250000	14250000	14250000	14250000	13300000	13300000	13300000
4	Less: variable cost	5700000	6650000	6650000	6650000	6650000	6650000	6650000	6175000	6175000	6175000
5	Contibution	5700000	7600000	7600000	7600000	7600000	7600000	7600000	7125000	7125000	7125000
6	Less:Fixed cost	950000	950000	950000	950000	950000	950000	950000	950000	950000	950000
7		4750000	6650000	6650000	6650000	6650000	6650000	6650000	6175000	6175000	6175000
8	Depreciation	720000	720000	720000	720000	720000	720000	720000	720000	720000	720000
9		18000000*4%
10		700000	700000	700000	700000	700000	700000	700000	700000	700000	700000
11		7000000/10
12	Earning before tax	3330000	5230000	5230000	5230000	5230000	5230000	5230000	4755000	4755000	4755000
13		C7-(C8+C10)
14	Less: tax(35%)	1165500	1830500	1830500	1830500	1830500	1830500	1830500	1664250	1664250	1664250
15	Earning after tax	2164500	3399500	3399500	3399500	3399500	3399500	3399500	3090750	3090750	3090750
16	Add:Depeciation	1420000	1420000	1420000	1420000	1420000	1420000	1420000	1420000	1420000	1420000
17	Cash flow from the operation	3584500	4819500	4819500	4819500	4819500	4819500	4819500	4510750	4510750	4510750
18	Less: change in working capital	2400000	3000000	3000000	3000000	3000000	3000000	3000000	3000000	3000000	3000000
19		1184500	1819500	1819500	1819500	1819500	1819500	1819500	1510750	1510750	1510750
20	Discounted value	1057589.286	1450494.26	1295084.161	1156325.144	1032433.164	921815.325	823049.3973	610166.5867	544791.5952	5.823849041
21	total value	C19/(1.12)^1									8891754.742	sum(C20:L20)
22	Increase in the value of land										800000
23	scrap value of castle										9000000
24											18691754.74
25											sum(L21:L23)
26	Initial cost
27	0 year working capital	1200000
28	Market survey cost	375000
29	castle construction	18000000
30	Equipment cost	7000000
31		26575000
32
33	NPV	-7883245.258