Question

Federal Express is contemplating a new venture project and has done a detailed five year cash flow estimate with the following result ($000):

            C₀                  C₁                   C₂                    C₃                    C₄                   C₅

            (300)                (60)                  70                    100                  120                  180

The firm’s cost of capital is 12%.

a. What is the project’s NPV and IRR, and make the appropriate recommendation to management.

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b. Peter Morton, Federal Express’s Marketing VP, has argued that it’s unreasonable to exclude cash flows past year five from the analysis. Calculate the project’s terminal value assuming year five’s cash flow goes on forever. Recalculate the project’s NPV and IRR under that Peter’ assumption.

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c. Peter further argues that the most appropriate assumption is that cash flows beyond the fifth year incorporate a three percent long run growth rate. Calculate the terminal value, NPV, and IRR implied by this assumption.

(Any advice on how to solve using excel is appreciated)

Answer 1

		A	B	C	D	E	F
	Year	0	1	2	3	4	5
1	Cash Flows	-300	-60	70	100	120	180
2	Cost of capital	12%
	NPV	-48.19
	NPV using Excel Formula=NPV(A2,B1:F1) + A1
	IRR	7.54%
	IRR using excel formula = IRR(A1:F1)

The projects NPV = - 48.19 and IRR is 7.54%
The Project should be rejceted because NPV is negative and it decreases the value of the firm and IRR is less than cost of capital so it shopuld be rejected.

2.

		A	B	C	D	E	F
	Year	0	1	2	3	4	5
1	Cash Flows	-300	-60	70	100	120	180
2	Terminal Cash flow at year 5 = Cash Flow at year5/Cost of Capital= 180/0.12						1500	(Terminal Value=180/0.12)
3	Total cash flow	-300	-60	70	100	120	1680
4	Cost of capital	12%
	NPV	802.95
	NPV using Excel Formula=NPV(A4,B3:F3) + A3
	IRR	46.35%
	IRR using excel formula = IRR(A3:F3)

Project's Terminal value = 1500
NPV = 802.95 and IRR = 46.35%
Hence project must be accepted as NPV is positive and IRR is greater than Cost of Capitlal

c)

		A	B	C	D	E	F
	Year	0	1	2	3	4	5
1	Cash Flows	-300	-60	70	100	120	180
2	Terminal Cash flow at year 5 = Cash Flow at year5(1+growth)/(Cost of Capital-growth)= 180*(1+3%)/(0.12-35)						2060	(Terminal Value=180*1.03/(0.12-0.03))
3	Total cash flow	-300	-60	70	100	120	2240
4	Cost of capital	12%
	NPV	1120.71
	NPV using Excel Formula=NPV(A4,B3:F3) + A3
	IRR	53.78%
	IRR using excel formula = IRR(A3:F3)

Terminal Cash flow = 2060,
NPV = 1120.71
IRR = 53.78%

Best of Luck. God Bless