In: Finance
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?
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