Question

Your firm is considering building a $599 million plant to manufacture HDTV circuitry. You expect operating profits​ (EBITDA) of $137 million per year for the next ten years. The plant will be depreciated on a​ straight-line basis over ten years​ (assuming no salvage value for tax​ purposes). After ten​ years, the plant will have a salvage value of $294 million​ (which, since it will be fully​ depreciated, is then​ taxable). The project requires $50 million in working capital at the​ start, which will be recovered in year ten when the project shuts down. The corporate tax rate is 35%. All cash flows occur at the end of the year.

a. If the​ risk-free rate is 4.3%​, the expected return of the market is 10.1%​, and the asset beta for the consumer electronics industry is 1.73​, what is the NPV of the​ project?

b. Suppose that you can finance $479 million of the cost of the plant using​ ten-year, 9.3% coupon bonds sold at par. This amount is incremental new debt associated specifically with this project and will not alter other aspects of the​ firm's capital structure. What is the value of the​ project, including the tax shield of the​ debt?

Answer 1

Part a)
Cost of capital = risk free rate+[Asset beta*(expected return of the market-risk free rate)] = 4.3%+[1.73*(10.1%-4.3%)] = 4.3%+(1.73*5.8%) = 4.3%+10.03% = 14.33%

Year	0	1-9	10
EBITDA (Given)		137,000,000	137,000,000
Depreciation (599million/10)		59,900,000	59,900,000
EBIT (EBITDA-Depreciation)		77,100,000	77,100,000
Tax @ 35% (EBIT*35%)		26,985,000	26,985,000
EAT (EBIT-Tax)		50,115,000	50,115,000
Add back: Depreciation		59,900,000	59,900,000
Operating cashflow (EAT+Depreciation)		100,230,000	100,230,000
Investment in plant (Given)	-599,000,000
Change in working capital (Given)	-50,000,000		50,000,000
Salvage value of plant (294million*65%)			191,100,000
Net cashflow	-649,000,000	100,230,000	341,330,000
PVF/PVAF @ 14.33%	1.00	4.8876	0.2621
Discounted cashflow (Net cashflow*PVF or PVAF)	-649,000,000	489,884,148	89,462,593

NPV of the project = ΣDiscounted cashflow = -69,653,259

Part b)

Year	0	1-9	10
EBITDA (Given)		137,000,000	137,000,000
Depreciation (599million/10)		59,900,000	59,900,000
EBIT (EBITDA-Depreciation)		77,100,000	77,100,000
Interest (479million*9.3%)		44,547,000	44,547,000
EBT (EBIT-interest)		32,553,000	32,553,000
Tax @ 35% (EBT*35%)		11,393,550	11,393,550
EAT (EBT-Tax)		21,159,450	21,159,450
Add back: Depreciation		59,900,000	59,900,000
Operating cashflow (EAT+Depreciation)		81,059,450	81,059,450
Investment in plant (Given)	-599,000,000
Change in working capital (Given)	-50,000,000		50,000,000
Salvage value of plant (294million*65%)			191,100,000
Net cashflow	-649,000,000	81,059,450	322,159,450
PVF/PVAF @ 14.33%	1.00	4.8876	0.2621
Discounted cashflow (Net cashflow*PVF or PVAF)	-649,000,000	396,186,168	84,437,992

Value of the project = ΣDiscounted cashflow = -168,375,840