Question

Fresh off the excitement of the 2012 London Olympic Games, you decide that you want your firm to take advantage of the profits to be made for the 2016 games in Rio de Janeiro. To do so you plan to open a factory in Brazil. After examining the idea, your CFO projects revenues next year (2013) to be $15 million and costs to be $7 million. Both of these are expected to grow at a rate of 22.0% per year as the excitement for the games builds. Your firm faces a 35% tax rate, a 13.5% discount rate and you can depreciate your new investment using the straight line method over the four years leading up to the games, at which point the value of the venture moving forward will be $7 million. This $7 million is the after-tax terminal value that is in year 4 (that is, 2016) dollars and is the PV of all cash flows year 5 and beyond. The capital expenditure of this project is $11 million. What is the NPV of the project? Assume that you have no significant working capital costs. (You are strongly encouraged to use a spreadsheet.) (Enter just the number in dollars without the $ sign or a comma and round off decimals to the closest integer, i.e., rounding $30.49 down to $30 and rounding $30.50 up to $31.)

Answer 1

NPV= $16.54 million

Year	Initial cost	Revenues	Costs	Depreciation	Profit before tax	Profit after tax	Cash flow after tax	Terminal value	Total cash flows
0	-11								-11.00
1		15.00	-7.00	-2.75	5.25	3.41	6.16		6.16
2		18.30	-8.54	-2.75	7.01	4.56	7.31		7.31
3		22.33	-10.42	-2.75	9.16	5.95	8.70		8.70
4		27.24	-12.71	-2.75	11.78	7.65	10.40	7	17.40
								NPV	$16.54

NOTES: Revenues and costs increase by 22% each year. Profit before tax= Revenues- costs-depreciation. Profit after tax= PBT*(1-Tax). Cash flows= Profit after tax + depreciation.

Formulae used as in the image below