Question

In: Finance

Down Under Boomerang, Inc. is considering a new three-year expansion project that requires an initial fixed...

Down Under Boomerang, Inc. is considering a new three-year expansion project that requires an initial fixed asset investment of $2.4 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which it will be worthless. The project is estimated to generate $2,050,000 in annual sales, with costs of $950,000. The tax rate is 35% and the required return is 12 percent. Calculate the projects NPV and IRR. Suppose that Down Under Boomerang is projected to grow at a rate of 4% after year 3. What is the value of the firm? Now, suppose the project requires an initial investment in net working capital of $285,000 and the fixed asset will have a market value of $225,000 at the end of the project. What are the new NPV and IRR? Now, what is the value of the firm?

Solutions

Expert Solution

1) . New NPV of the project is $11777

CALCULATIONS

year

0

1

2

3

cost

-2400000

annual sales

2050000

2050000

2050000

cost

-950000

-950000

-950000

Depreciation (2400000/3)

-800000

-800000

-800000

EBT

300000

300000

300000

Tax

105000

105000

105000

net income

195000

195000

195000

Add depreciation

800000

800000

800000

operating cash flow

995000

995000

995000

Discounted cash flow calculation;

year

0

1

2

3

cost

-2400000

NWC

-285000

285000

operating cash flows

995000

995000

995000

cash flow from sale of fixed asset

146250

Total cash flows

-2685000

995000

995000

1426250

PVIF @12%

1

0.892857

0.797194

0.71178

Discounted cashflows

-2685000

888392.9

793207.9

1015177

sum of discounted cash flows from year 1,2 and 3 =2696777

NPV = sum of discounted cash flows from operating years – initial investment

NPV = 2696777 – 2685000

NPV = 11777

2). IRR of the project is 12.24% (trial and error method)

The NPV with discount rate 12% is positive (2696777), therefore lets assume IRR to be 13%

NPV @ 13%= (995000 * (PVIF 13%,1))+ (995000 * (PVIF 13%,2)) + (1426250 * (PVIF 13%,3))- 2685000

NPV @ 13% = -36755

Since the NPV with 13% discount rate is negative we have to interpolate using the following formula: -

IRR = 12% + [(13%-12%) * (11700/ 11700+ 36775)}]

= 12% + .24%

IRR = 12.24% Approx.

3). Value of the firm is 6606910

CALCULATIONS:

Growth = .04

Year 4 = (2050000-950000) * (1-.35) *1.04

Year 4 = 743600

NPV of project (only operating cash flow) = 995000 * PVIFA12%,3)-2400000

NPV of project (only operating cash flow) = -9087.40

Value = 743600/ ((.12-.04) *(1+.12) ^3) + (-9087.40)

Value = 6606910


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