Question

1. You have the following cost and revenue information on a project that invests in the conversion of a coal-fired electricity generating plan into a gas-fired unit.

Cost of new equipment: $200 million.

The equipment will be depreciated over 8 years on a straight-line basis to zero book value.

Proceeds from the sale of old equipment which has a book value of $15 m is 40 million,

Expensible installation cost: 0.50 million.

Estimated Revenue from the sale of electricity in the first year: $65 million and it remains the same for all 5 years;

Cost of gas: $25 million;

Operating and other expenses: $4 million;

Initial working capital expenses: $1 million;

Project’s assets estimated resale value: $65 million.

The project is subject to a tax rate of 30%,

Anticipated clean-up expense: $1.0 million.

The investment is eligible for $1.0 million investment tax credit.

The weighted average cost of capital (WACC) of the project is 5%.

Using these data,

1. calculate the following cash flows associated with the project: (i) Net initial investment outlay; (ii) Net operating cash flows (NOCF) also known as CFAT and (iii) net salvage value, and

assuming that the net operating cash flows will remain the same for all five years, calculate the NPV and the IRR of the project.

Please show all work

Answer 1

	(i)	Net initial investment outlay
	A	Cot of equipment	($200,000,000)
	B	Proceeds from sale of equipment	$40,000,000
	C	Book value of old equipment	$15,000,000
	D=B-C	Gain on sale of old equipment	$25,000,000
	E	Tax rate	30%
	F=D*E	Tax on gain onsale of old equipment	$7,500,000
	G=B-F	Net cash flow from sale of old equipment	$32,500,000
	H	Expensible installation cost	($500,000)
	I	Initial Working capital expenses	($1,000,000)
	J	Investment Tax Credit	$1,000,000
	K=A+G+H+I+J	Net initial investment outlay	($168,000,000)
	(ii)	Net Operating Cash Flow
	L	Depreciable Assets	$200,500,000	(200000000+500000)
	M=L/8	Annual Depreciation	$25,062,500
	N	Annual Revenue	$65,000,000
	P	Cost of gas	($25,000,000)
	Q	Operating and other expenses	($4,000,000)
	R	Depreciation expenses	($25,062,500)
	S=N+P+Q+R	Income before taxes	$10,937,500
	T=S*30%	Taxe expenses	-$3,281,250
	U=S+T	Operating Income	$7,656,250
	V	Depreciation expenses(Non cash)	$25,062,500
	W=U+V	Net Operating Cash Flow	$32,718,750
	(iii)	Net salvage value
	X=5*V	Accumulated Depreciation at end of year5	$125,312,500
	Y=L-X	BookValue at end of 5 years	$75,187,500
	RV	Resale value at end of year 5	$65,000,000
	LR=Y-RV	Loss on Resale	$10,187,500
	TS=LR*0.3	Tax saving on loss	$3,056,250
	Z=RV+TS	Net salvage value	$68,056,250
		CALCULATION OF NPV and IRR
		Present Value (PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=Discount Rate=WACC=5%=0.05
		N=Year of Cash Flow
	N	Year	0	1	2	3	4	5
	a	Net Initial Investment Outlay	($168,000,000)
	b	Net Operating Cash Flow		$32,718,750	$32,718,750	$32,718,750	$32,718,750	$32,718,750
	c	Net salvage value						$68,056,250
	d	Release of initial working capital						$1,000,000
	e	Clean up expenses						($1,000,000)
	f=a+b+c+d+e	Net Cash Flow	($168,000,000)	$32,718,750	$32,718,750	$32,718,750	$32,718,750	$100,775,000	SUM
	PV=f/(1.05^N)	Present Value of Net Cash Flow	($168,000,000)	$31,160,714	$29,676,871	$28,263,686	$26,917,797	$78,959,849	$26,978,917
	NPV=Sumof PV	Net Present Value (NPV)	$26,978,917
		Internal Rate of Return (IRR)	9.67%	(Using IRR function of excel   over Net CashFlow)