Question

Working as a general partner for the exclusive private-equity boutique PPP (Prey Preditor Partners), who specialize in snapping up distressed high-tech firms and restructuring them for an often handsome profit, you recently have come across a tantalizing investment opportunity. Broken Promises Access, Inc. (BPA), a bankrupt WiFi access and mobile telephony operator, has offered you one of the most advanced, as of yet unused WiFi networks (including launch services) for USD 300m in cash. Having raised funds from institutional investors for precisely these type of “vulture” investments in troubled IT assets, you wonder whether to set up a new firm, HotPoint Access (HPA), that would purchase, complete and operate BPA’s WiFi network.

In order to make the final decision and prepare investor presentations to your fund’s limited partners, you have asked one of your junior associates, fresh out of business school, to run the numbers. Should you be able to complete the network ahead of the competition, HPA would most likely operate under following financial scenario:

• expected revenues from the WiFi sales will be $100 million per year for the next 10 years if the network can be completed on time;

• operating costs for the network are $35 million, again per year for the next 10 years;

• the initial cost of the network will be depreciated over 10 years using straight-line de-

  preciation;

• the network has a useful life of 10 years and no salvage value as it will be obsolete by then;

• you will also need $10 million in net working capital at year 0 to start up the business;

• the corporate tax rate is 34%.

1. (a) What are the cash flows? Present a table.

2. (b) What is the project’s NPV when the appropriate (all-equity) cost of capital is 10.80%? Is it worthwhile to undertake it?

3. (c) What is the IRR? Is the internal rate of return higher or lower than the ROE? Justify your answer.

4. (d) By spending an additional $200 million on aggressive marketing upfront, PPP estimates that it could raise expected revenue by 50%. How, if at all, would this additional investment change your conclusions to (b) and (c)?

5. (e) Optional. Given the intense competition for setting up WiFi hotspots by retailers, mobile phone companies, and coffee shops such as Starbucks, there is a 10% probability that you will be beaten to the market by a competitor. In this event, all access contracts
   will be void so that revenue and operating costs will be zero and the entire cost of the network can be written off for tax purposes. Assuming that these tax credits can be offset against other profits from another firm in your portfolio that you would merge with upon failure, what is the NPV of forming HPA now? Would the inclusion of the downside risks in your analysis change your previous decision?

Answer 1

Answering the first 4 part of question as per HomeworkLib policy.

Answer a,b,c)

year	0	1	2	3	4	5	6	7	8	9	10
Cost of network	-$300.00
Net working capital	-$10.00
Total cost	-$310.00
Sales		$100.00	$100.00	$100.00	$100.00	$100.00	$100.00	$100.00	$100.00	$100.00	$100.00
Operating cost		-$35.00	-$35.00	-$35.00	-$35.00	-$35.00	-$35.00	-$35.00	-$35.00	-$35.00	-$35.00
EBITD		$65.00	$65.00	$65.00	$65.00	$65.00	$65.00	$65.00	$65.00	$65.00	$65.00
Depreciation		-$30.00	-$30.00	-$30.00	-$30.00	-$30.00	-$30.00	-$30.00	-$30.00	-$30.00	-$30.00
EBIT		$35.00	$35.00	$35.00	$35.00	$35.00	$35.00	$35.00	$35.00	$35.00	$35.00
Tax (@ 34%)		-$11.90	-$11.90	-$11.90	-$11.90	-$11.90	-$11.90	-$11.90	-$11.90	-$11.90	-$11.90
EAT		$23.10	$23.10	$23.10	$23.10	$23.10	$23.10	$23.10	$23.10	$23.10	$23.10
Add Dep		$35.00	$35.00	$35.00	$35.00	$35.00	$35.00	$35.00	$35.00	$35.00	$35.00
Return of Working capital											$10.00
Cash flow	-$310.00	$58.10	$58.10	$58.10	$58.10	$58.10	$58.10	$58.10	$58.10	$58.10	$68.10
Cost of Equity	10.80%
NPV	$38.64		NPV(10.8%,C15:L15)+B15
IRR	13.652%		IRR(B15:L15)

NPV>0, It is worthwhile to undertake it.

internal rate of return (13.652%) is higher than the ROE(10.80%)

Answer d)

year	0	1	2	3	4	5	6	7	8	9	10
Cost of network	-$300.00
Net working capital	-$10.00
Addition cost	-$200.00
Total cost	-$510.00
Sales		$150.00	$150.00	$150.00	$150.00	$150.00	$150.00	$150.00	$150.00	$150.00	$150.00
Operating cost		-$35.00	-$35.00	-$35.00	-$35.00	-$35.00	-$35.00	-$35.00	-$35.00	-$35.00	-$35.00
EBITD		$115.00	$115.00	$115.00	$115.00	$115.00	$115.00	$115.00	$115.00	$115.00	$115.00
Depreciation		-$30.00	-$30.00	-$30.00	-$30.00	-$30.00	-$30.00	-$30.00	-$30.00	-$30.00	-$30.00
EBIT		$85.00	$85.00	$85.00	$85.00	$85.00	$85.00	$85.00	$85.00	$85.00	$85.00
Tax (@ 34%)		-$28.90	-$28.90	-$28.90	-$28.90	-$28.90	-$28.90	-$28.90	-$28.90	-$28.90	-$28.90
EAT		$56.10	$56.10	$56.10	$56.10	$56.10	$56.10	$56.10	$56.10	$56.10	$56.10
Add Dep		$35.00	$35.00	$35.00	$35.00	$35.00	$35.00	$35.00	$35.00	$35.00	$35.00
Return of Working capital											$10.00
Cash flow	-$510.00	$91.10	$91.10	$91.10	$91.10	$91.10	$91.10	$91.10	$91.10	$91.10	$101.10
Cost of Equity	10.80%
NPV	$34.62		NPV(10.8%,C15:L15)+B15
IRR	12.377%		IRR(B15:L15)

NPV>0, It is worthwhile to undertake it.

internal rate of return (12.377%) is higher than the ROE(10.80%)

So, No change in decision