Question

Forecasting and Firm Valuation 7. (10) Wayward Products is considering a new project that requires an investment of $24 million in machinery. This is expected to produce sales of $70 million per year for 3 years. Operating expenses are 80% of sales. The machinery will be fully depreciated to a zero-book value over 3 years using straight-line depreciation. There is no salvage value. There is an initial investment of $3 million in net operating working capital. At the end of year 3, the firm gets $2 million returned in net operating working capital. There is no other investment in net operating working capital. The tax rate is 25%. The unlevered cost of capital is 11%. a. Calculate the base-case NPV (net present value). b. The project will be financed with $10,000,000 in bonds; the remaining funds will come from retained earnings. The bonds have a 3-year life, an annual coupon rate of 6% and a yield of 6%. Find the adjusted present value (APV). You do NOT need to rebalance for the changing debt.

Answer 1

$24 million $3 million 70 million Tritical Investment Titial working capitala Expected produced sale of operating Edfeuse = 8ox of sols Machinery will be fully deprecated to gero book value in 3 you the firm get back 2 million returned in net woolking of Nwe Tax Rate 25% (WACC) Unlevered cost of capital = 11% Чел? a ) Яеал 2 Year 1 Sales 70 70 70 operating Exp. 80% of 56 56 56 soles gross profit 14 14 14 8 8 8 (-Depreciation (-) Interest Exp ЕВТ 6 6 6 (-) Tas -1.5 1.5 1.5 PAT 4.5 4.5 4.5 FC FF = PAT + De povreciation (change in networking capital t Topitel Exp.) 8- co +o) 4.5+ $ 12.5 mn fresent Value = + + t FLFFI FC FF 2 FLFF3 (1 + WALL) (I+WALL) (IT WALL) 12.5 12.5 12.5 (1+1%)? (+11%)* 11:261 10.145 t g. 139 - $ 30.545 mn (1 + 117) +

2 Present value of & Returned NWC (1 +WACC) $ 1.462 Mn NPV = Prool P. V of FLFF + PV of NW () - (p. of coger out flow) (36.546 + 1.4162) (24 + 3) 38 32.008 $5.008 27 Mn bond. o coupon Rute 10mn by the project will be financed with 6%. 2. Adjusted present value Tax shield Tax x Interest Rate & loon/bond amount 25. X 10 = $0.15 Mn Present value of tax shield = 0.15 0.15 | +671) 1+691 (1+6%) 64 X 0.15 + - = 0.40l Mn + APV = NPU freest value of tax shield 5.008 + 0.401m $5.409 mn