Question

Bauer Industries is an automobile manufacturer. Management is currently evaluating a proposal to build a plant that will manufacture lightweight trucks. Bauer plans to use a cost of capital of 12.2 % to evaluate this project. Based on extensive​ research, it has prepared the incremental free cash flow projections shown below​ (in millions of​ dollars):

Year	0	​1-9	10
Revenues		100.4	100.4
Manufacturing Expenses​ (other than​ depreciation)		-33.2	-33.2
Marketing Expenses		-10.3	-10.3
Depreciation		-15.2	-15.2
EBIT		41.7	41.7
Taxes at 35​%		-14.6	-14.6
Unlevered Net Income		27.1	27.1
Depreciation		+15.2	+15.2
Additions to Net Working Capital		-5.4	-5.4
Capital Expenditures	-151.5
Continuation Value			+11.6
Free Cash Flow	-151.5	36.9	48.5

a. For this​ base-case scenario, what is the NPV of the plant to manufacture lightweight​ trucks?

b. Based on input from the marketing​ department, Bauer is uncertain about its revenue forecast. In​ particular, management would like to examine the sensitivity of the NPV to the revenue assumptions. What is the NPV of this project if revenues are 8 % higher than​ forecast? What is the NPV if revenues are 8 % lower than​ forecast?

c. Rather than assuming that cash flows for this project are​ constant, management would like to explore the sensitivity of its analysis to possible growth in revenues and operating expenses.​ Specifically, management would like to assume that​ revenues, manufacturing​ expenses, and marketing expenses are as given in the table for year 1 and grow by 2% per year every year starting in year 2. Management also plans to assume that the initial capital expenditures​ (and therefore​ depreciation), additions to working​ capital, and continuation value remain as initially specified in the table. What is the NPV of this project under these alternative​ assumptions? How does the NPV change if the revenues and operating expenses grow by 6 % per year rather than by 2 %​?

d. To examine the sensitivity of this project to the discount​ rate, management would like to compute the NPV for different discount rates. Create a​ graph, with the discount rate on the x​-axis and the NPV on the y​-axis, for discount rates ranging from 5 % to 30%. For what ranges of discount rates does the project have a positive​ NPV?

Answer 1