High Flyer, Inc., is considering an investment in a new distribution center. High Flyer’s CFO anticipated...

High Flyer, Inc., is considering an investment in a new distribution center. High Flyer’s CFO anticipated additional earnings before interest and taxes of $100,000 for the first year of operation of the center, and, over the next five years, the firm estimates that this amount will grow at a rate of 5% per year. The distribution center will require an initial investment of $600,000 that will be depreciated over a five-year period toward a zero salvage value using straight-line depreciation. It is estimated that the distribution center will need operating net working capital equal to 25% of EBIT to support operation. At the end of the 5th year, High Flyer will sell the distribution center for an estimated amount of $10,000. High Flyer’s WACC is 19% and it faces a 30% tax rate. Part a What is the value of this project? Part b Should the company undertake this project? Part c Under what condition will you change your recommendation?

Solutions

Expert Solution

Net value calculation of the project:

Year (n)	Initial Investments	Depreciation (D)	Salvage value	Earnings before interest and taxes (EBIT)	Net Working Capital (NWC) (25% of EBIT)	Before taxes cash flow (BTCF) (EBIT-NWC + Salvage value)	Taxable Income (BTCF - depreciation)	Income taxes (Taxable Income *30%)	After Tax Net Income (taxable income - taxes)	Free Cash Flow = ( Net Income + depreciation)	PV of after tax cash flow @19% = FCF/ (1+19%)^t
0	-$600,000									-$600,000	-$600,000
1		$120,000		$100,000	$25,000	$75,000	-$45,000	-$13,500	-$31,500	$88,500	$74,370
2		$120,000		$105,000	$26,250	$78,750	-$41,250	-$12,375	-$28,875	$91,125	$64,349
3		$120,000		$110,250	$27,563	$82,688	-$37,313	-$11,194	-$26,119	$93,881	$55,711
4		$120,000		$115,763	$28,941	$86,822	-$33,178	-$9,953	-$23,225	$96,775	$48,259
5		$120,000	$10,000	$121,551	$30,388	$101,163	-$18,837	-$5,651	-$13,186	$106,814	$44,760
Value of the project											-$312,551


Note:
1. Salvage value of fixed asset at the end of year 5 is taken as income and fully taxed.
2. For Negative Taxable Income, a tax credit is assumed

a. What is the value of this project?

The value of this project -$312,551

b. Should the company undertake this project?

The company should not undertake this project as the value of this project is negative.

c. Under what condition will you change your recommendation?

If the value of the project become positive at current discount rate (WACC =19%) then company can undertake this project.

keosha answered 1 year ago

Next > < Previous

Related Solutions

Nu Things, Inc., is considering an investment in a business venture with the following anticipated cash...

Nu Things, Inc., is considering an investment in a business venture with the following anticipated cash flow results: EOY Cash Flow 0 -$90,000 1 $22,000 2 $21,000 3 $20,000 4 $19,000 5 $18,000 6 $17,000 7 $16,000 8 $15,000 9 $14,000 10 $13,000 11 $12,000 12 $11,000 13 $10,000 14 $9,000 15 $8,000 16 $7,000 17 $6,000 18 $5,000 19 $4,000 20 $3,000 Assume MARR is 20% per year. Based on an external rate of return analysis: Q) Determine the...

High Flyer, Inc., wishes to maintain a growth rate of 13.75 percent per year and a...

High Flyer, Inc., wishes to maintain a growth rate of 13.75 percent per year and a debt–equity ratio of .45. The profit margin is 4.7 percent, and total asset turnover is constant at 1.17. What is the dividend payout ratio? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Dividend payout ratio % What is the...

High Flyer, Inc., wishes to maintain a growth rate of 14.5 percent per year and a...

High Flyer, Inc., wishes to maintain a growth rate of 14.5 percent per year and a debt-equity ratio of .6. The profit margin is 4.4 percent, and total asset turnover is constant at 1.14. a. What is the dividend payout ratio? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. What is the maximum sustainable growth rate for this...

To alleviate the strained distribution system, BeeRUS is considering the opening of an additional distribution center....

To alleviate the strained distribution system, BeeRUS is considering the opening of an additional distribution center. The consideration is for a large (maximum capacity 30,000 bottles), medium (maximum capacity 25,000 bottles) or small (maximum capacity 20,000 bottles) distribution center. The Operations Management team estimated that the predicted demand may change depending on the economic development. At the moment the economy is stagnant. If the economy improves, the team estimates an increase in sales of 15%, however a decrease in sales...

Gluon Inc. is considering the purchase of a new high pressureglueball. It can purchase the...

Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the glueball for $60,000 and sell its old low-pressure glueball, which is fully depreciated, for $10,000. The new equipment has a 10-year useful life and will save $14,000 a year in expenses. The opportunity cost of capital is 11%, and the firm’s tax rate is 21%. What is the equivalent annual saving from the purchase if Gluon can depreciate 100% of the investment immediately. (Do...

Ella, Inc. is considering a new capital budgeting project (the “Investment”). The Investment will cost $102,030...

Ella, Inc. is considering a new capital budgeting project (the “Investment”). The Investment will cost $102,030 that must be invested today, and $105,000 that must be invested at the end of year one. The Investment will have the following net cash inflows at the end of each of the next three years. Year 1: $50,000; Year 2: $75,000; and Year 3: $100,000. The financial accounting net operating income for each of the next three years is as follows: Year 1:...

• Your firm is considering building a new manufacturing and distribution facility via direct investment in...

• Your firm is considering building a new manufacturing and distribution facility via direct investment in Latin America. Management narrowed the potential locations to Mexico, Bolivia, and Venezuela. Evaluate any cultural barriers your firm may experience in each of the three countries.

Average Rate of Return—New Product Galactic Inc. is considering an investment in new equipment that will...

Average Rate of Return—New Product Galactic Inc. is considering an investment in new equipment that will be used to manufacture a smartphone. The phone is expected to generate additional annual sales of 6,500 units at $269 per unit. The equipment has a cost of $604,500, residual value of $45,500, and an eight-year life. The equipment can only be used to manufacture the phone. The cost to manufacture the phone follows: Cost per unit: Direct labor $45.00 Direct materials 175.00 Factory...

You are the CFO and are considering introducing a new product that will require an initial...

You are the CFO and are considering introducing a new product that will require an initial investment in equipment of $6 million. The equipment will be depreciated straight line over 3 years to a value of zero, and can be sold after 3 years for $500,000. Working capital at each date must be maintained at a level of 10% of the following year’s forecast sales. You estimate production costs at $1.50 /unit and the sales price at $4/unit. Sales forecasts...

Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the...

Gluon Inc. is considering the purchase of a new high pressure glueball. It can purchase the glueball for $110,000 and sell its old low-pressure glueball, which is fully depreciated, for $20,000. The new equipment has a 10-year useful life and will save $24,000 a year in expenses. The opportunity cost of capital is 10%, and the firm’s tax rate is 21%. What is the equivalent annual saving from the purchase if Gluon can depreciate 100% of the investment immediately. (Do...

Subjects