Question

Fox Pty Ltd (Fox) is a listed company on ASX and is aiming to invest $500,000 into a new product line. The residual value of this investment at the end of 5 years would be $50,000, which is depreciated using Straight Line Method.

This investment brings additional net operating income of $80,000 which would be increased by 7% each year till year 5. Also, for this investment, Fox is required to invest 3% of the new net operating income each year. Having tax rate of 30%, calculate:

a) Investment Free Cash Flows for years 0 to 5?

b) NPV if discount rate (WACC) is 9%?

c) NPV if the growth rate of net operating income is change by +2% and -2% (from 7%. it is changed to 9% and 5% respectively), discount rate is still 9%.

Answer 1

a)

 

Since NOI < Depreciation, there will be losses in the books, and hence no tax on cash flows.

Additional investment = 3% of cashflows

 

b)

NPV if discount rate is 9% = (-) USD 120,515

 

c)

NPV is growth in NOI is increased by 2% i.e.to 9% = (-) USD 108,587

NPV is growth in NOI is decreased by 2% i.e.to 5% = (-) USD 132,008

 

If discount rate is 9%, this investment project should not be undertaken as NPV is negative.

 

Other methods to evaluate the project is by calculating IRR, calculating payback period. However, NPV is the best method to evaluate the project if the WACC is known and there is limitation of surplus capital.