JT Inc Following is the seven-year forecast for a new venture called JT Inc: (all amounts...

JT Inc

Following is the seven-year forecast for a new venture called JT Inc: (all amounts in $000)

	2020	2021	2022	2023	2024	2025	2026
EBIT	$(1000)	$(900)	$200	$1,200	$2,500	$3000	$3,050
Capital Expenditures	$550	$350	$200	$175	$175	$160	$150
Changes in Working Capital	$400	$300	$200	$100	$100	($100)	($100)
Depreciation	$40	$80	$125	$150	$150	$150	$150

Beginning after year 2026 the annual growth in EBIT is expected to be 1.5%, a rate that is projected to be constant over JT Inc remaining life as an enterprise. Beginning in 2026 JT Inc capital expenditures and depreciation are expected to offset each other (capex - depreciation = 0) and year to year changes in working capital are expected to be zero (working capital levels remain constant year over year). For discounting purposes consider 2020 as year 1.

Assume a tax rate is 21% and a cost of capital of 7.75%

Determine the NPV of JT Inc Free Cash Flow for the years 2020 -2026. HINT: Remember to account for loss carry-forwards when determining income taxes.

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Expert Solution

All amounts mentioned are in $000

First, we calculate the free cash flows from years 2020 to 2026:

Losses in 2020 and 2021 are $1000 + $900, which is $1900. This loss is carried forward, and set off against EBIT of future years. The EBIT of 2022 and 2023 ($1,400) is entirely set off against the carried forward losses. In 2024, the remaining carried forward loss of $500 is set off against EBIT of $2500. The tax payment in 2024 is ($2,500 - $500) * 21%. In 2025 and 2026, tax payment = EBIT * 21%

Free cash flow = EBIT - tax + deprecation - increase in working capital - capital expenditure

Each of these free cash flows are discounted back to the present using the discount rate of 7.75%

Present value of free cash flow of year X = free cash flow / (1 + 7.75%)^X

Sum of these free cash flows = $2,105

Next, we calculate the value of the future cash flows after 2026:

EBIT in 2027 = $3,050 + 1.5% ==> $3,095.75

Free cash flow in 2027 = EBIT(1 - tax rate) ==> $3,095.75 (1 - 0.79) ==> $2,445.64

As the expenditures and depreciation are expected to offset each other (capex - depreciation = 0) and year to year changes in working capital are expected to be zero, no other adjustments to EBIT are required

Terminal value of free cash flows (in 2026) = Free cash flow in 2027 / (cost of capital - constant growth rate)

Terminal value in 2026 = $2,445.64 / (0.0775 - 0.015) ==> $39,130.24

Present value of Terminal value = $39,130.24 / (1 + 0.0775)^7 ==> $23,206

NPV = sum of PV of free cash flows + PV of terminal value

NPV = $2,105 + $23,206

NPV = $25,311

jeff jeffy answered 1 year ago

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