CORPORATE FINANCE – TERM 2/2023
GROUP ASSIGNMENT 2
Company Y intends to launch a new project with the following information:
- The project requires an initial investment in fixed assets of $6,000,000.
- This investment will be depreciated straight-line over five years to a value of zero.
- When the project comes to an end at the end of five years, the equipment will be sold for
$500,000.
- The firm believes that working capital at each date must be maintained at 10% of next year’s
forecasted sales starting immediately.
- Production costs are estimated at 25% of revenue.
- Sales forecasts (in $) are given in the following table:
Year 0 1 2 3 4 5
Sales 0 2,000,000 2,400,000 4,000,000 4,000,000 2,400,000
- The tax rate is 25% and the discount rate of the project is 12%.
Calculate the NPV of the project.
Answer
● Sales
Year 1 = $2,000,000
Year 2 = $2,400,000
Year 3 = $4,000,000
Year 4 = $4,000,000
Year 5 = $2,400,000
● Cost
Production costs are estimated at 25% of revenue.
- Production costs:
Year 1 = $2,000,000 * 25% = $500,000
Year 2 = $2,400,000 * 25% = $600,000
Year 3 = $4,000,000 * 25% = $1,000,000
Year 4 = $4,000,000 * 25% = $1,000,000
Year 5 = $2,400,000 * 25% = $600,000
● Depreciation
This investment will be depreciated straight-line over 5 years to a value of zero.
Cost of Initial Investment $ 6,000,000
Straight-line depreciation = = =$1,200,000
Useful life 5
⇒ Depreciation (year 1->5) = $1,200,000
● EBIT
EBIT = Sales - Costs - Depreciation
Year 0 = $0
Year 1 = $2,000,000 - $500,000 - $1,200,000 = $300,000
Year 2 = $2,400,000 - $600,000 - $1,200,000 = $600,000
Year 3 = $4,000,000 - $1,000,000 - $1,200,000 = $1,800,000
Year 4 = $4,000,000 - $1,000,000 - $1,200,000 = $1,800,000
Year 5 = $2,400,000 - $600,000 - $1,200,000 = $600,000
● TAX
Tax rate = 25%
=> Tax = EBIT x 25%
Year 0 = $0
Year 1 = $300,000 * 25% = $75,000
Year 2 = $600,000 * 25% = $150,000
Year 3 = $1,800,000 * 25% = $450,000
Year 4 = $1,800,000 * 25% = $450,000
Year 5 = $600,000 * 25% = $150,000
● Net Income
NI = EBIT - TAX
Year 1 = $300,000 - $75,000 = $225,000
Year 2 = $600,000 - $150,000 = $450,000
Year 3 = $1,800,000 - $450,000 = $1,350,000
Year 4 = $1,800,000 - $450,000 = $1,350,000
Year 5 = $600,000 - $150,000 = $450,000
● Operating cash flows
OCF = EBIT + Depreciation - Taxes
Year 0 = $0
Year 1 = $300,000 + $1,200,000 - $75,000 = $1,425,000
Year 2 = $600,000 + $1,200,000 - $150,000 = $1,650,000
Year 3 = $1,800,000 + $1,200,000 - $450,000 = $2,550,000
Year 4 = $1,800,000 + $1,200,000 - $450,000 = $2,550,000
Year 5 = $600,000 + $1,200,000 - $150,000 = $1,650,000
● Acc. Dep Year, Adjusted basis of equipment
Year 1 Year 2 Year 3 Year 4 Year 5
Depreciation 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000
(calculated above)
- Accumulated depreciation:
Year 1 = Dep. Year 1 = $1,200,000
Year 2 = Acc. Dep. Year 1 + Dep. Year 2 = $1,200,000+ $1,200,000 = $2,400,000
Year 3 = Acc. Dep. Year 2 + Dep. Year 3 = $2,400,000+ $1,200,000 = $3,600,000
Year 4 = Acc. Dep. Year 3 + Dep. Year 4 = $3,600,000+ $1,200,000 = $4,800,000
Year 5 = Acc. Dep. Year 4 + Dep. Year 5 = $4,800,000+ $1,200,000 = $6,000,000
- Adjusted basis of equipment = Cost of Initial Investment - Accumulated depreciation
Year 1 = $6,000,000 - $1,200,000 = $4,800,000
Year 2 = $6,000,000 - $2,400,000 = $3,600,000
Year 3 = $6,000,000 - $3,600,000 = $2,400,000
Year 4 = $6,000,000 - $4,800,000 = $1,200,000
Year 5 = $6,000,000 - $6,000,000 = $0
● After-tax salvage revenue
The equipment will have a salvage value at the end of the project => the aftertax salvage
value:
Pretax salvage value = $500,000
Taxes on sale = (Pretax salvage value - Adjusted basis of equipment Year 5) * %Tax
= ($500,000 - 0) * 25% = $125,000
Aftertax salvage value = Pretax salvage value - Taxes on sale
= $500,000 - $125,000 = $375,000
● NWC
NWC at each date must be maintained at 10% of the next year’s forecasted sales starting
immediately.
- Beginning NWC:
Year 0 = 0
Year 1 = $2,000,000*10%= $200,000
Year 2 = $2,400,000*10% = $240,000
Year 3 = $4,000,000*10% = $400,000
Year 4 = $4,000,000*10% = $400,000
Year 5 = $2,400,000*10% = $240,000
- End of year NWC:
Year 0 = $200,000
Year 1 = $240,000
Year 2 = $400,000
Year 3 = $400,000
Year 4 = $240,000
Year 5 = $0 (The project ended in year 5).
- NWC cash flow:
Year 0 = $0 - $200,000 = $ -200,000
Year 1 = $200,000 - $240,000 = $ -40,000
Year 2 = $240,000 - $400,000 = $ -160,000
Year 3 = $400,000 - $400,000 = $0
Year 4 = $400,000 - $240,000 = $ 160,000
Year 5 = $240,000 - $0 = $ 240,000
● Total cash flow of project
- Total cash flow of project = OCF + NWC + Initial Investment
Year 0 = $ -6,000,000 + $ -200,000 = $ -6,200,000
Year 1 = $1,425,000 + $ -40,000 = $1,385,000
Year 2 = $1,650,000 + $ -160,000 = $1,490,000
Year 3 = $2,550,000 + $0 = $2,550,000
Year 4 = $2,550,000 + $160,000 = $2,710,000
Year 5 = $1,650,000 + $240,000 + $375,000= $2,265,000
● The present value
Total cash flow of project
- The present value: n
(1+ r)
- Discount Rate: 12%.
$−6,200,000
Year 0 = 0 = $-6,200,000
(1+12 %)
$ 1,385,000
Year 1 = 1 = $1,236,607
(1+12 % )
$ 1,490,000
Year 2 = 2 = $1,187,819
(1+12 % )
$ 2,550,000
Year 3 = 3 = $1,815,040
(1+12 % )
$ 2,710,000
Year 4 = 4 = $1,722,254
(1+12 %)
$ 2,265,000
Year 5 = 5 = $1,285,222
(1+12 % )
❑
● NPV = ∑ ❑ Present value (Year 0 -> Year 5)
❑
NPV = $ -6,200,000 + $1,236,607 + $1,187,819 + $1,722,254 + $1,285,222 = $1,046,941
=> NPV = $1,046,941
EXCEL
