Question

Kitchen Envy produces cabinets to order. It is a mature business that earned EBITDA of $950,000 on revenues of $6million in the most recent year and is expected to continue to generate these figures in perpetuity. The company is considering carrying some of its most popular models in inventory, with an eye on increasing sales and operating profits. It has collected the following information:

• With the inventory, the company expects its annual revenues to increase to $7.7 million and its overall EBITDA margin (EBITDA as % of sales) to increase to 20%.

• For the next decade, the inventory will be maintained at 11% of total revenues, with the investment made at the start of each year. The inventory will be sold for book value at the end of 10 years.

• The cost of capital for the company is 11% and it faces a 40% tax rate.

A. Estimate the NPV of the project (carrying inventory) assuming at ten-year life for the investment.

B. Estimate the breakeven EBITDA margin for the company, for the investment to have a zero NPV, if you now assume that the project lasts forever

Answer 1

Assumption:

I) Zero depriciation and no salvage value

Cashflow schedule & NPV

	Curent	Next Deceade	Incremental	Depriciation	Incre EBIT	New EBITDA Margin
Revenue	$           60,00,000	$       77,00,000	$       17,00,000			20%
EBITDA	$              9,50,000	$       15,40,000	$          5,90,000	$                  -	$             5,90,000
	Year0	Year1	Year2	Year3	Year4	Year5	Year6	Year7	Year8	Year9	Year10
Increamental EBIT		$          5,90,000	$          5,90,000	$     5,90,000	$             5,90,000	$                     5,90,000	$   5,90,000	$   5,90,000	$   5,90,000	$   5,90,000	$   5,90,000
+ Depriciation		$                       -	$                       -	$                  -	$                          -	$                                  -	$                -	$                -	$                -	$                -	$                -
-Tax		$          2,36,000	$          2,36,000	$     2,36,000	$             2,36,000	$                     2,36,000	$   2,36,000	$   2,36,000	$   2,36,000	$   2,36,000	$   2,36,000
Increamental OCF(a)		$          3,54,000	$          3,54,000	$     3,54,000	$             3,54,000	$                     3,54,000	$   3,54,000	$   3,54,000	$   3,54,000	$   3,54,000	$   3,54,000
Net Working Cap (b)
Inventory	$            -8,47,000										$   8,47,000
Capital Spending ©	$                           -	$                       -	$                       -	$                  -	$                          -	$                                  -	$                -	$                -	$                -	$                -	$                -
Total Project CF (a + B + c)	$            -8,47,000	$          3,54,000	$          3,54,000	$     3,54,000	$             3,54,000	$                     3,54,000	$   3,54,000	$   3,54,000	$   3,54,000	$   3,54,000	$ 12,01,000
Cost of Capital	11%
NPV	$     15,36,088.39

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To find the NPV = 0, easiest way to do goal seek in x-cel, setting NPV cell = 0 , by changing incremental EBIT row which comes to $ 329170. Since, depriciation is assumed to 0, incremental EBITDA wil $ 329170 which is increased over curent EBITDA 950000. Total EBITDA margin for Zero NPV = (950000+329170) / 7700000 = 17%

	Year0	Year1	Year2	Year3	Year4	Year5	Year6	Year7	Year8	Year9	Year10
Increamental EBIT		$          3,29,170	$          3,29,170	$     3,29,170	$             3,29,170	$                     3,29,170	$   3,29,170	$   3,29,170	$   3,29,170	$   3,29,170	$   3,29,170
+ Depriciation		$                       -	$                       -	$                  -	$                          -	$                                  -	$                -	$                -	$                -	$                -	$                -
-Tax		$          2,36,000	$          2,36,000	$     2,36,000	$             2,36,000	$                     2,36,000	$   2,36,000	$   2,36,000	$   2,36,000	$   2,36,000	$   2,36,000
Increamental OCF(a)		$             93,170	$             93,170	$         93,170	$                93,170	$                        93,170	$       93,170	$       93,170	$       93,170	$       93,170	$       93,170
Net Working Cap (b)
Inventory	$            -8,47,000										$   8,47,000
Capital Spending ©	$                           -	$                       -	$                       -	$                  -	$                          -	$                                  -	$                -	$                -	$                -	$                -	$                -
Total Project CF (a + B + c)	$            -8,47,000	$             93,170	$             93,170	$         93,170	$                93,170	$                        93,170	$       93,170	$       93,170	$       93,170	$       93,170	$   9,40,170
Cost of Capital	11%
NPV	$                           -
Break Even EBITDA %	17%