Question

ZIPE Co. which is the market leader in the sector in which it operates, wants to continue its
success in the international arena. First of all, firm plans to open a store in the city center of
Berlin, Germany. The CEO of the company traveled with the senior managers and asked the
finance manager to submit a feasibility report. The finance manager has reached the
following figures in coordination with other departments.
The rentals of the shops in the area where investment is planned are quite expensive.
Nevertheless, it is not a situation that cannot be tolerated both in terms of the target
customer volume and the prestige of the company. The rental cost a shop in this area of the
firm will be € 240,000 per year. Also, in Germany, wages are expected to be higher than in
Turkey. The number of personnel required is determined and the total cost is expected to be
€ 300,000. In addition to these costs, the company is expected to incur operating costs of €
120,000 annually. By the way, it is necessary to advertise with a huge commercial campaign.
The € 200,000 ad budget for the first year will be reduced to € 50,000 in the following years.
In spite of these costs, the company is expected to reach a sales figure of € 6,500,000 for the
first year. In a project with a 10-year economic life expectancy, sales will rise to € 7,000,000
for the second year, € 7,500,000 for the third year, and € 8,000,000 for the third year and
will remain stable at this level. Firms earn up(increase) to 20% of gross profits and 80% of sales.
In order for the firm to open such a shop in Germany, it has to invest a fixed asset of €
5,000,000. It is expected that the scrap value of the investment made at the end of 10 years
will be zero. The tax rate for the firm is 20%, the cost of capital is 8% and the depreciation is
straight line method.

So, what would be your decision as a finance manager?

Answer 1

The project gives negative NPV hence the project should not accept.

NPV = Sum of discounted cashflow = -5,000,000+ 407,396+569,247+581,062+596,820+552,647+511,722+473,802 +438,724+406,244+376,118 = -86,218

Sl.No	Year	0	1	2	3	4	5	6	7	8	9	10
i	Expected sales (given)		6,500,000	7,000,000	7,500,000	8,000,000	8,000,000	8,000,000	8,000,000	8,000,000	8,000,000	8,000,000
ii	Gross profit (i*20%)		1,300,000	1,400,000	1,500,000	1,600,000	1,600,000	1,600,000	1,600,000	1,600,000	1,600,000	1,600,000
iii	Rent, wages & operating costs (given)		(660,000)	(660,000)	(660,000)	(660,000)	(660,000)	(660,000)	(660,000)	(660,000)	(660,000)	(660,000)
iv	Advertisement (given)		(200,000)	(50,000)	(50,000)	(50,000)	(50,000)	(50,000)	(50,000)	(50,000)	(50,000)	(50,000)
v	EBITDA (ii-iii-iv)		440,000	690,000	790,000	890,000	890,000	890,000	890,000	890,000	890,000	890,000
vi	Depreciation (5million/10years)		(500,000)	(500,000)	(500,000)	(500,000)	(500,000)	(500,000)	(500,000)	(500,000)	(500,000)	(500,000)
vii	EBIT (v+vi)		(60,000)	190,000	290,000	390,000	390,000	390,000	390,000	390,000	390,000	390,000
viii	Tax @ 20% (vii*0.2) (note 1)		-	(26,000)	(58,000)	(78,000)	(78,000)	(78,000)	(78,000)	(78,000)	(78,000)	(78,000)
ix	Profit after tax (vii+viii)		(60,000)	164,000	232,000	312,000	312,000	312,000	312,000	312,000	312,000	312,000
x	Add: Depreciation		500,000	500,000	500,000	500,000	500,000	500,000	500,000	500,000	500,000	500,000
xi	Less: Investment in equipments (given)	5,000,000
xii	Free cashflows (ix+x-xi)	(5,000,000)	440,000	664,000	732,000	812,000	812,000	812,000	812,000	812,000	812,000	812,000
xiii	Present value factor @ 8% (note 2)	1	0.9259	0.8573	0.7938	0.7350	0.6806	0.6302	0.5835	0.5403	0.5003	0.4632
xiv	Discounted cash flows (xii*xiii)	(5,000,000)	407,396	569,247	581,062	596,820	552,647	511,722	473,802	438,724	406,244	376,118

Note 1:

In 1st year the company incurred loss, hence there will be no tax in 1st year.

In 2nd year the loss of 1st year is carry forward & adjust against the profit of 2nd year to compute tax. Assume Carry forward & adjustment of loss is allowed.

Note 2:

PVF @ 8% for 1st year = 1/[(1+discount rate)^year] = 1/(1.08^1) = 0.9259

PVF @ 8% for 2nd year = 1/[(1+discount rate)^year] = 1/(1.08^2) = 0.8573

PVF @ 8% for 3rd year = 1/[(1+discount rate)^year] = 1/(1.08^3) = 0.7938

similarly continuesly have to calculate upto to 10th year