In: Finance
The MacCauley Company has sales of $200 million and total operating expenses (excluding depreciation) of $130 million. Straight-line depreciation on the company's assets is $15 million over 4 years. The Upfront Cost equals to the total depreciable value on the company’s assets. Assume that all taxable income is taxed at 30 percent. Assume also that net operating working is 3% of sales in each year. Calculate the MacCauley Company's WACC using 4% cost of debt, 12% cost of equity. There is 45% equity and 55% debt are on the company’s balance sheet. What is NPV? Would you invest in the project? Is IRR greater or smaller than WACC? What is the payback period? (There is no salvage value at the end of 4 years)
Calculation of WACC
Weight of debt = 55%, Cost of debt = 4% , Weight of equity = 45% , Cost of Equity = 12%, Tax rate = 30%
WACC = Weight of debt x Cost of debt x (1- tax rate) + Weight of Equity x Cost of Equity = 55% x 4% x (1-30%) + 45% x 12% = 55% x 4% x 70% + 45% x 12% = 1.54% + 5.4% = 6.94%
Calculating upfront cost
Annual straight line depreciation = $15 million
Total upfront cost = No of years x Annual straight line depreciation = 4 x 15 = 60 million
Calculating investment in net working capital
Working capital required at beginning of year = Sales for the year x 3%
Working capital required in year 0 or beginning of year 1 = Sales for year 1 x 3% = 200 x 3% = $6 million
Incremental investment in working capital in year 0 =$6 million
Working capital required at beginning of year 2 or in year 1 = Sales in year 2 x 3% = 200 x 3% = $6 million
Incremental investment in working capital in a year = Working capital required in a year - Working capital required in previous year
Incremental investment in year 1 = Working capital required for year 1 - Working capital required for year 0 = 6 - 6 = 0 million
Negative value in year 4 represents recovery of cash from sale of working capital
Calculation of Incremental Investment in Working Capital | ||||||
Year | 0 | 1 | 2 | 3 | 4 | 5 |
Sales | 0 | 200 | 200 | 200 | 200 | 0 |
Working Capital Required | 6 | 6 | 6 | 6 | 0 | |
Incremental Investment Working capital | 6 | 0 | 0 | 0 | -6 |
Calculating After tax operating cash flows
After tax operating cash flow = EBIT(1-tax rate) + Depreciation = (Sales - Cost - Depreciation)(1-tax rate) + Depreciation = (200 - 130 - 15)(1-30%) + 15 = 55(1-30%) + 15 = 38.50 + 15 = $53.50 million
Calculating Net cash flows
Calculating Net Cash Flows (in $ million) | |||||
Year | 0 | 1 | 2 | 3 | 4 |
Initial Upfront Cost (a) | -60 | ||||
After tax operating Cash Flow (b) | 53.50 | 53.50 | 53.50 | 53.50 | |
Incremental Investment in Working Capital (c) | 6 | 0 | 0 | 0 | -6 |
Net Cash Flow = (a) + (b) - (c) | -66 | 53.5 | 53.5 | 53.5 | 59.5 |
Year | 0 | 1 | 2 | 3 | 4 |
Net Cash Flow (in $) | -66000000 | 53500000 | 53500000 | 53500000 | 59500000 |
Calculating NPV of the project
NPV = Cash flow in year 0 + Sum of present values of cash flows for year 1 to 4 discounted at WACC
= -66000000 + 535000000 / ( 1 + 6.94%) + 535000000 / ( 1 + 6.94%)2 + 535000000 / ( 1 + 6.94%)3 + 595000000 / ( 1 + 6.94%)4
= -66000000 + 50028053.1139 + 46781422.3993 + 43745485.6923 + 45494222.4339 = 120049183.6394 = 120049183.64 (Rounded to two decimal places)
Since NPV of the project is greater than 0, therefore investment should be made in the project
Calculating IRR of the project
IRR of the project can be found out using IRR function in excel
Formula to be used in excel: =IRR(Cash flows)
Using IRR function in excel, we get IRR of project = 72.689% = 72.69%
IRR is greater than WACC
Calculating Payback period
For calculating payback period, we will calculate cumulative cash flows
Cumulative cash flow in year 0 = Net cash flow in year 0 = -66000000
Cumulative cash flow in year = Cumulative cash flow for previous year + Net cash flow for a year
Cumulative cash flow for year 1 = cumulative cash flow for year 0 + net cash flow for year 1 = -66000000 + 53500000 = -12500000
Similarly cumulative cash flow can be found out for other years
Year | 0 | 1 | 2 | 3 | 4 |
Net Cash Flow (in $) | -66000000 | 53500000 | 53500000 | 53500000 | 59500000 |
Cumulative Cash Flows | -66000000 | -12500000 | 41000000 | 94500000 | 151000000 |
Cumulative cash flow change sign from negative to positive in year 2, therefore
Pay back period = 1 + (12500000 / 53500000) = 1 + (0.2336) = 1.2336= 1.23 years ( rounded to two decimal places)