Question

The following information pertains to Fairways Driving Range, Inc.:

The company is considering operating a new driving range facility in Sanford, FL. In order to do so, they will need to purchase a ball dispensing machine, a ball pick-up vehicle and a tractor and accessories for a total cost of $105,000. All of this depreciable equipment will be 7-year MACRS property. The project is expected to operate for 6 years, at the end of which the equipment will be sold for 25% of its original cost. Fairways expects to have $35,000 of fixed costs each year other than depreciation. These fixed costs include the cost of leasing the land for the driving range.

Fairways expects to have sales for the first year of $105,000 based on renting 21,000 buckets of balls @ $5 per bucket. For years 2-6, they expect the number of buckets rented to steadily increase by 1,100 buckets per year, while the price will remain constant @ $5. Expenditures needed for buckets and balls each year are expected to be 20% of the gross revenues for the year.

Fairways will be in the 40% tax bracket for all years in question.

The company has a required capital structure of 45% debt and 55% equity. They can issue new bonds to yield 5%. With respect to equity, the company’s beta is 1.75 the expected return on the market is 10% and the risk-free rate is 4%. Use this information to compute the company’s WACC and then use the WACC as the required return for this project.

Please complete the following tables to determine the NPV for Fairways Driving Range, Inc.’s proposed Sanford venture. PLEASE ROUND ALL FIGURES TO THE NEAREST WHOLE DOLLAR!

For each year of the project, compute the profit margin and EPS (assuming that the firm has 15,000 shares of stock outstanding). Besides the net value of the fixed assets, the company also expects to have $20,000 of other assets. Compute the total assets for each year, use the 45%/55% ratio to determine the total amounts of liability and equity for each year, and use those figures to compute ROA and ROE for each year.

	0*	1	2	3	4	5	6
Sales
Variable Costs
Fixed Costs
Depreciation
EBIT
Taxes
Net Income
EBIT
Depreciation
Taxes
OCF
Net Capital Spending
Cash Flow From Assets
Present Value
NPV (just put overall NPV in Year 0 column)
Profit Margin
EPS
Total Assets
Total Liabilities
Total Equity
ROA
ROE

Answer 1

		Year	0	1	2	3	4	5	6	7	8
	a	Number of buckets of balls rented		21000	22100	23200	24300	25400	26500
	b	Price per bucket		$5	$5	$5	$5	$5	$5
	c=a*b	Sales		$105,000	$110,500	$116,000	$121,500	$127,000	$132,500
		Calculation of depreciation:
	d	7-year MACRS depreciation rate		14.29%	24.49%	17.49%	12.49%	8.93%	8.92%	8.93%	4.46%
	e=d*105000	AnnualDepreciation		$15,005	$25,715	$18,365	$13,115	$9,377	$9,366
	f	Accumulated depreciation		$15,005	$40,719	$59,084	$72,198	$81,575	$90,941
	g=105000-f	Year End Book Value		$89,996	$64,281	$45,917	$32,802	$23,426	$14,060
		Cash flow fromSalvage:
	h=0.25*105000	Salvage value at end of year 6							$26,250
	i=h-g	Gain on salvage							$12,191
	j=i*0.40	Tax ongain onsalvage							$4,876
	k=h-j	Net cash flow fromsalvage							$21,374
		Calculation of Cost of capital:
	wd	Weight of debt	0.45
	we	Weight of equity	0.55
	cd	Cost of debt	3%	(5*(1-0.4)
	ce	Cost of equity=rf+beta*(rm-rf)
		rf=risk free rate=4%, rm=market return=10%,Beta=1.75,
	ce	Cost of Equity=4+1.75*(10-4)	14.50%
	cc	Cost of Capital=wd*cd+we*ce
	cc	Cost of capital=0.45*3+0.55*14.5	9.325%	-0.09325
	N	YEAR	0	1	2	3	4	5	6
	A	Sales		$105,000	$110,500	$116,000	$121,500	$127,000	$132,500
	B=0.2*A	Variable Costs		$21,000	$22,100	$23,200	$24,300	$25,400	$26,500
	C	Fixed Costs		$35,000	$35,000	$35,000	$35,000	$35,000	$35,000
	D	Depreciation		$15,005	$25,715	$18,365	$13,115	$9,377	$9,366
	E=A-B-C-D	EBIT		$33,996	$27,686	$39,436	$49,086	$57,224	$61,634
	F=E*0.4	Taxes		$13,598	$11,074	$15,774	$19,634	$22,889	$24,654
	G=E-F	Net Income		$20,397	$16,611	$23,661	$29,451	$34,334	$36,980
	H	Depreciation		$15,005	$25,715	$18,365	$13,115	$9,377	$9,366
	I=G+H	OCF		$35,402	$42,326	$42,026	$42,566	$43,711	$46,346
	J	Net Capital Spending	($105,000)						$21,374
	K=I+J	Cash Flow From Assets	($105,000)	$35,402	$42,326	$42,026	$42,566	$43,711	$67,720	SUM
	PV=K/(1.09325^N)	Present Value	($105,000)	$32,382	$35,413	$32,163	$29,798	$27,989	$39,664	$92,410
		NPV (just put overall NPV in Year 0 column)	$92,410
	L=G/A	Profit Margin		19.43%	15.03%	20.40%	24.24%	27.03%	27.91%
	M=G/15000	EPS		$1.36	$1.11	$1.58	$1.96	$2.29	$2.47
	N	Total Assets	$125,000	$145,397	$162,009	$185,670	$215,121	$249,455	$286,436