1. You have been given the following information on a project:
- It has a 5-year lifetime
- The initial investment in the project will be $25 million, and the investment will be depreciated straight line, down to a salvage value of $10 million at the end of the fifth year.
- The revenues are expected to be $20 million next year and to grow 10% a year after that for the remaining 4 years.
- The cost of goods sold, excluding depreciation, is expected to be 50% of revenues.
- The tax rate is 40%.
a. Estimate the pre-tax return on capital, by year and on average, for the project.
b. Estimate the after-tax return on capital, by year and on average, for the project.
c. If the firm faced a cost of capital of 12%, should it take this project.
2. You are provided with the projected income statements for a project:
|
Year
|
1
|
2
|
3
|
4
|
|
Revenues
|
$ 10,000
|
$ 11,000
|
$12,000
|
$13,000
|
|
- Cost of Goods Sold
|
$ 4,000
|
$ 4,400
|
$ 4,800
|
$ 5,200
|
|
- Depreciation
|
$ 4,000
|
$ 3,000
|
$ 2,000
|
$ 1,000
|
|
= EBIT
|
$ 2,000
|
$ 3,600
|
$ 5,200
|
$ 6,800
|
- The tax rate is 40%.
- The project required an initial investment of $15,000 and an additional investment of $2,000 at the end of year 2.
- The working capital is anticipated to be 10% of revenues, and the working capital investment has to be made at the beginning of each period.
a. Estimate the free cash flow to the firm for each of the 4 years.
b. Estimate the payback period for investors in the firm.
c. Estimate the net present value to investors in the firm, if the cost of capital is 12%. Would you accept the project?
d. Estimate the internal rate of return to investors in the firm. Would you accept the project?
3. You are provided with the following cash flows on a project:
|
Year
|
Cash Flow to Firm
|
|
0
|
- 10,000,000
|
|
1
|
$ 4,000,000
|
|
2
|
$ 5,000,000
|
|
3
|
$ 6,000,000
|
Plot the net present value profile for this project. What is the internal rate of return? If this firm had a cost of capital of 10% and a cost of equity of 15%, would you accept this project?
4. You have to pick between three mutually exclusive projects with the following cash flows to the firm:
|
Year
|
Project A
|
Project B
|
Project C
|
|
0
|
-$10,000
|
$ 5,000
|
-$15,000
|
|
1
|
$ 8,000
|
$ 5,000
|
$ 10,000
|
|
2
|
$ 7,000
|
-$8,000
|
$10,000
|
The cost of capital is 12%.
a. Which project would you pick using the net present value rule?
b. Which project would you pick using the internal rate of return rule?
c. How would you explain the differences between the two rules? Which one would you rely on to make your choice?
5. You are helping a manufacturing firm decide whether it should invest in a new plant. The initial investment is expected to be $ 50 million, and the plant is expected to generate after-tax cashflows of $ 5 million a year for the next 20 years. There will be an additional investment of $ 20 million needed to upgrade the plant in 10 years. If the discount rate is 10%,
a. Estimate the Net Present Value of the project.
b. Prepare a Net Present Value Profile for this project.
c. Estimate the Internal Rate of Return for this project. Is there any aspect of the cashflows that may prove to be a problem for calculating IRR?