Question

In: Finance

) Firm XYZ is contemplating an expansion of £400 million of its existing business. Of this...

) Firm XYZ is contemplating an expansion of £400 million of its existing business. Of this initial investment, £380 million will be used to buy a new plant and £20 million will be invested in net working capital today (Year 0). The investment will be fully financed by new debt raised at 15% interest. The corporate tax rate is 40%. The asset cost of capital (that is, the discount rate that applies to unlevered free cash flows) is 20%. XYZ's management has produced the following forecasts (pro-forma) for the

expansion project for the next two years in case they undertake the expansion (in millions of pounds):

Year

0

1

2

EBIT

750

950

Depreciation

150

170

Capex (Capital Expenditures)

150

170

NWC (net working capital)

20

22

24

The terminal value of this project (as of Year 3) is zero, and debt will be fully repaid by the end of Year

2.

(a) Calculate the free cash flows and the interest tax shields for Years 1 and 2.

(b) Calculate the value of the project at Year 0, after the investment is made. What is the net present value of the project?

Solutions

Expert Solution

Free cash flows for year 1 = (EBIT - Interest)*(1-tax rate) - Net Capex - Change in NWC

= [(750-400*0.15)*(1-0.4)] - (150-150) - (22-20)

= (750-60)*0.6 - 0 -2

= 690*0.6 - 2

= 414 - 0 -2 = pound 412 million

Free cash flows for year 2 = (EBIT - Interest)*(1-tax rate) - Net Capex - Change in NWC

= [(950-400*0.15)*(1-0.4)] - (170-170) - (24-22)

= (950-60)*0.6 - 0 - 2

= 890*0.6 - 2

= 534 - 0 - 2 = pound 532 million

Interest tax shield for year 1 & 2 = Interest *tax rate

= pound 400 million *15%(0.4)

= pound 60 million *0.4

= pound 24 million

Value of the project in year 0 = Pound 400 million

Net present value of the project = Discounted Free cashflow - Initial Investment

= Cashflow in year 1/(1+discount rate) + Cashflow in year 2/(1+discount rate)^2 - Initial investment

= [412 million/(1+0.2)] + [532 million/(1+0.2)^2] - 400 million

= 412 million/1.2 + 532 million/(1.2)^2 - 400 million

= 343.33 million + 532 million/1.44 - 400 million

= 343.33 million + 369.44 million/1.44 - 400 million

= 312.77 million

jeff jeffy answered 1 year ago
Next > < Previous

Related Solutions

A firm is contemplating investment to the tune of Rs.750 million on an expansion plan. The...
A firm is contemplating investment to the tune of Rs.750 million on an expansion plan. The firm’s current ROI is 20%, and the proposed investment will improve it to 25%. The current investment is Rs.1000 million. The firm’s current debt to equity ratio is 1:1. The existing cost of debt at 15%. The equity share capital is represented by 10 million shares, which are currently traded at Rs.300 per share. New debt can be raised at 18% and new equity...
“BLACKFRIDAY” company is planning an expansion of its existing production capacity. The firm hired you as...
“BLACKFRIDAY” company is planning an expansion of its existing production capacity. The firm hired you as a consultant for the expansion project. Since you are a savvy project manager, you first decided to estimate the firm’s cost of capital based on the available data. Data: Tax Rate: 40% Bond: Coupon rate 12%, Maturity Years 15, Present value $1150 Preferred Stock: Dividend rate 10%, Par Value $100, Present Value $111 Common Stock: Market price $50, D0=$4.20, Dividend growth 5%, Beta 1.2,...
“BLACKFRIDAY” company is planning an expansion of its existing production capacity. The firm hired you as...
“BLACKFRIDAY” company is planning an expansion of its existing production capacity. The firm hired you as a consultant for the expansion project. Since you are a savvy project manager, you first decided to estimate the firm’s cost of capital based on the available data. Data: Tax Rate: 40% Bond: Coupon rate 12%, Maturity Years 15, Present value $1150 Preferred Stock: Dividend rate 10%, Par Value $100, Present Value $111 Common Stock: Market price $50, D0=$4.20, Dividend growth 5%, Beta 1.2,...
You are a consultant to a firm evaluating an expansion of its current business.
You are a consultant to a firm evaluating an expansion of its current business. The cash-flow forecasts (in millions of dollars) for the project are as follows: Years Cash Flow 0 – 100 1-10 + 17 On the basis of the behavior of the firm’s stock, you believe that the beta of the firm is 1.39. Assuming that the rate of return available on risk-free investments is 6% and that the expected rate of return on the market portfolio is...
You are a consultant to a firm evaluating an expansion of its current business. The annual...
You are a consultant to a firm evaluating an expansion of its current business. The annual cash flow forecasts (in millions of dollars) for the project are:             Years Annual Cash Flow 0 -83 1 - 10 11         Based on the behaviour of the firm's stock, you believe that the beta of the firm is 1.4. Assuming that the rate of return available on risk-free investments is 6% and that the expected rate of return on the market portfolio...
You are a consultant to a firm evaluating an expansion of its current business. The annual...
You are a consultant to a firm evaluating an expansion of its current business. The annual cash flow forecasts (in millions of dollars) for the project are:             Years Annual Cash Flow 0 -83 1 - 10 11         Based on the behaviour of the firm's stock, you believe that the beta of the firm is 1.4. Assuming that the rate of return available on risk-free investments is 6% and that the expected rate of return on the market portfolio...
Summary: In 2020, XYZ Co. has an existing loan in the amount of $1.5 million with...
Summary: In 2020, XYZ Co. has an existing loan in the amount of $1.5 million with an annual interest rate of 9.5%. The company provides an internal company prepared financial statement to the bank under the loan agreement. Two competing banks have offered to replace XYZ’s existing loan agreement with a new one, starting 2021. Sadaf Remo Bank has offered to loan XYZ $1.5 million at a rate of 8.5% but would require XYZ to provide financial statements that have...
You are a consultant to a firm evaluating an expansion of its current business. The cash-flow...
You are a consultant to a firm evaluating an expansion of its current business. The cash-flow forecasts (in millions of dollars) for the project are as follows: Years Cash Flow 0 – 100 1-10 + 17 On the basis of the behavior of the firm’s stock, you believe that the beta of the firm is 1.32. Assuming that the rate of return available on risk-free investments is 3% and that the expected rate of return on the market portfolio is...
You are a consultant to a firm evaluating an expansion of its current business. The cash-flow...
You are a consultant to a firm evaluating an expansion of its current business. The cash-flow forecasts (in millions of dollars) for the project are as follows: Years Cash Flow 0 – 100 1-10 + 17 On the basis of the behavior of the firm’s stock, you believe that the beta of the firm is 1.44. Assuming that the rate of return available on risk-free investments is 5% and that the expected rate of return on the market portfolio is...
Type 2D: You are a consultant to a firm evaluating an expansion of its current business....
Type 2D: You are a consultant to a firm evaluating an expansion of its current business. The cash-flow forecasts (in millions of dollars) for the project are as follows. Year 0: initial outlay of 100, Years 1 to 8: 18 each year. On the basis of the behavior of the firm’s stock, you believe that the beta of the firm is 1.0. Assuming that the rate of return available on risk-free investment is 4% and that the expected rate of...
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT