Question

Carpel Tunnel Gold Mine (CTGM) is evaluating a project with a 2-year life. As consultant, you are given the following information.

Table 1: Data related to CTGM’s proposed expansion project.

Tax Rate	40%
Initial Investment	$1,000,000
Salvage Value at any time during the project	$100,000
Initial Investment in Net Working Capital	$50,000
Sales Year 1	$2,000,000
Sales Year 2	$4,000,000
Annual Operating Costs (each year)	$200,000
3-Year MACRS Depreciation Schedule
Year 1	.3333
Year 2	.4444
Year 3	.1482
Year 4	.0741

Table 2: Data related to CTGM’s capital structure:

Tax Rate	40%
Cost of Equity	18%
Coupon Rate	8%
Yield to Maturity on Debt	6%
Term to Maturity	20 years
Coupon Payments	Semi-Annual
Face Value of a Bond	$1,000
Quantity of Bonds Outstanding	15,000
Market Value of the Firm	$48,467,215.80

Table 3: Data related to the Pure Play Company’s cost of capital:

Tax Rate	40%
YTM	7%
Cost of Equity	23%

1. Assume it is an expansion project. What is the NPV of the expansion project?

b.Now assume CTGM’s project is in a new line of business. Use information from the pure play company to re-estimate the WACC and find the NPV of the project

Answer 1

(A) Workings - semi- annual interest

value of bond =   interest * PVAF ( 3%,40 periods) + redeem value * PVF( 3% ,40 period)

= ($ 40 * 23.114) + ($ 1000 * 0.3065)

= $924.59 + 306.50

= $ 1231.09

total market value of bond = 15000 * $ 1231.09

= $ 18466350

Value of firm = $ 48,467,215.80

value of equity = $ 48,467,215.80 - $ 18466350 = 30000865.80

Weight of equity = 0.6189  

weight of debt = 0.3810

wacc = weight of equity * cost of equity + weight of debt * cost of debt

=     0.6189 * 0.18 + 0.3810 * 0.8 (1-0.4)

= 12.97 %

initial exp = 1000000 + 50000 = $ 1050000

interest esp = 15000*1000*8% = 1200000

Loss on salvage at 2nd year end = 222300-100000 = $122300

Particulars	year1	year 2
Sales	2000000	4000000
less -operating cost	200000	200000
dep	333300	444400
EBIT	1466700	3355600
interest	1200000	1200000
EBT	266700	2155600
Tax @ 40%	106680	862240
EAT	160020	1293360
Add Dep	333300	444400
FCF	493320	1737760

NPV OF PROJECT

year	cash flow	PVF @ 12.97 %	Present Value
0	- 1050000	1.000	-1050000
1	493320	0.8852	436686.86
2	1737760	0.7835	1361534.96
2	122300*.40 = (48920)	0.7835	-38328.82
2	50000	0.7835	39175.00
		NPV	749068.82

(B) workings

value of bond =   interest * PVAF ( 3.5%,40 periods) + redeem value * PVF( 3.5% ,40 period)

= ($ 40 * 21.355) + ($ 1000 * 0.2526)

= $ 854.20 + 252.60

= $ 1106.80

total market value of bond = 15000 * $ 1106.8

= $ 16602000

Value of firm = $ 48,467,215.80

value of equity = $ 48,467,215.80 - $ 16602000 = 31865215.80

Weight of equity = 0.6575

weight of debt = 0.34.25

wacc = weight of equity * cost of equity + weight of debt * cost of debt

=     0.6575 * 0.23 + 0.3425 * 0.8 (1-0.4)

= 16.76 %

NPV OF PROJECT

year	cash flow	PVF @ 16.76 %	Present Value
0	- 1050000	1.000	-1050000
1	493320	0.8565	422528.58
2	1737760	0.7335	1274646.96
2	122300*.40 = (48920)	0.7335	-35882.82
2	50000	0.7335	36675.00
		NPV	647967.72