Question

(Determining relevant cash flows) Landcruisers Plus (LP) has operated an online retail store selling off-road truck parts. As the name implies, the firm specializes in parts for the venerable Toyota FJ40 that is known throughout the world for its durability and offroad prowess. The fact that Toyota stopped building and exporting the FJ40 to the U.S. market in 1982 meant that FJ40 owners depended more and more on re-manufactured parts to keep their beloved off-road vehicles running. More and more FJ40 owners are replacing the original inline six-cylinder engines with a modern American-built engine. The engine replacement requires mating the new engine with the Toyota drive train.

LP's owners had been offering engine adaptor kits for some time but have recently decided to begin building their own units. To make the adaptor kits the firm would need to invest in a variety of machine tools costing a total of $800,000. LP's management estimates that they will be able to borrow $300,000 from the firm's bank and pay 8 percent interest. The remaining funds would have to be supplied by LP's owners.

The firm estimates that they will be able to sell 1,000 units a year for $1,400 each. The units would cost $1,000 each in cash expenses to produce (this does not include depreciation expense of $80,000 per year or interest expense of

$24 000 ). After all expenses, the firm expects earnings before interest and taxes of $320,000. The firm pays taxes equal to 31 percent, which results in net income of $196 comma 800 per year over the 10 -year expected life of the equipment.

a. What is the annual free cash flow LP should expect to receive from the investment in year 1 assuming that it does not require any other investments in either capital equipment or working capital and the equipment is depreciated over a 10 -year life to a zero salvage and book value? How should the financing cost associated with the $300 comma 000 loan be incorporated into the analysis of cash flow?

b. If the firm's required rate of return for its investments is 11 percent and the investment has a 10 -year expected life, what is the anticipated NPV of the investment?

Answer 1

Annual Free cash flow = Net Income + Depreciation
		196800+80000
		276800
The Interest expense on the loan taken shall be deducted every year to determine the free cash flows of the company
Years	Cashflows	Interest on Loan aftr tax	Principal Payment	Cashflow inflow from Project	Discounting Factor @ 11%	Present Value
0	-500000	0		-500000	1	-500000
1	276800	16560	20708.85	239531.15	0.90909091	217755.6
2	276800	15416.87	22365.56	239017.571	0.82644628	197535.2
3	276800	14182.29	24154.8	238462.905	0.7513148	179160.7
4	276800	12848.95	26087.19	237863.866	0.68301346	162464.2
5	276800	11408.93	28174.16	237216.903	0.62092132	147293
6	276800	9853.721	30428.09	236518.184	0.56447393	133508.3
7	276800	8174.09	32862.34	235763.567	0.51315812	120984
8	276800	6360.089	35491.33	234948.581	0.46650738	109605.2
9	276800	4400.968	38330.64	234068.396	0.42409762	99267.85
10	276800	2285.116	41397.09	233117.797	0.38554329	89877
	Net Present Value					957451.2
Assuming the Loan has equal installments yearly installments and using the PMT formula in excel we get yearly payment of $44708.85
Years	Loan Outstanding at the beginning	Interest Payment	Principal Payment	Total Payment	Loan outstanding at the end	Aftr Tax Interest @31%
1	3,00,000.00	24000	20708.85	44708.85	2,79,291.15	16560
2	2,79,291.15	22343.29	22365.56	44708.85	2,56,925.59	15416.87
3	2,56,925.59	20554.05	24154.8	44708.85	2,32,770.79	14182.29
4	2,32,770.79	18621.66	26087.19	44708.85	2,06,683.60	12848.95
5	2,06,683.60	16534.69	28174.16	44708.85	1,78,509.44	11408.93
6	1,78,509.44	14280.76	30428.09	44708.85	1,48,081.35	9853.721
7	1,48,081.35	11846.51	32862.34	44708.85	1,15,219.00	8174.09
8	1,15,219.00	9217.52	35491.33	44708.85	79,727.67	6360.089
9	79,727.67	6378.214	38330.64	44708.85	41,397.04	4400.968
10	41,397.04	3311.763	41397.09	44708.85	-0.05	2285.116