Question

5. (Comprehensive problem) Traid Winds Corporation, a firm in the 36 percent marginal tax bracket with a required rate of return or cost of capital of 11 percent is considering a new project. This project involves the introduction of a new product. The project is expected to last 5 years and then, because this is somewhat of a fad product, be terminated. Given the Information in the popup window, determine the free cash flows associated with the project, the projects net present value, the profitability index, and the internal rate of return. Apply the appropriate decision criteria. a. What is the initial outlay associated with this project? (Round to the nearest dollar) b. What is the annual free cash flow associated with this project in year 17 (Round to the nearest dollar.) What is the annual free cash flow associated with this project in year 2? (Round to the nearest dollar.) What is the annual free cash flow associated with this project in year 3? (Round to the nearest dollar.) What is the annual free cash flow associated with this project in year 47 (Round to the nearest dollar.) c. What is the terminal cash flow in year 5 (that is, what is the free cash flow in year 5 plus any additional cash flows associated with the termination of the project)? (Round to the nearest dollar.) d. What is the project's NPV given a required rate of return of 11 percent? (Round to the nearest dollar.) Based on the NPV criterion, should the project be accepted? (Select the best choice below.) O A. Yes. The project should be accepted because its NPV is positive. OB. No. The project should be rejected because its NPV is negative. e. What is the project's Pl given a required rate of return of 11 percent? (Round to three decimal places.) Based on the P/ criterion, should the project be accepted? (Select the best choice below.) A. Yes. The project should be accepted because its Pl is greater than 1. B. No. The project should be rejected because its Pl is less than 1. What is the project's IRR? % (Round to two decimal places.) ed on the IRR criterion, should the project be accepted? (Select the best choice below.) Yes. The project should be accepted because its IRR is greater than the required rate of return, 11%. detlofinance

Answer 1

Answers for first 4 subparts parts:

1. Initial Outlay = Fixed Capital Investment + Working Capital Investment + adjustments from old project(– Salvage Value + (Salvage Value – Book Value ) X (Tax Rate) )

In this case, project is new. Therefore

Initial Outlay = Fixed Capital Investment + Working Capital

= Cost of New Plant and Equipment + Shipping and installing costs + initial working capital required

= 14,400,000 + 300,000 + 280,000

= 14,980,000 (Answer a)

Free cashflow = Net Income + non-cash expenses – Increase in Working Capital – capex

1) Net Income:

Below Table Summarizes the calculation for Net Income.

Note: all Calculations in ‘000.

Year	1	2	3	4	5
Units Sold	60	110	110	70	60
Revenue	24000	44000	44000	28000	21000
COGS	9600	17600	17600	11200	9600
Gross Profit	14400	26400	26400	16800	11400
Annual fixed Cost	900	900	900	900	900
IBITDA	13500	25500	25500	15900	10500
Depreciation	2940	2940	2940	2940	2940
IBIT	10560	22560	22560	12960	7560
tax(@36%)	3802	8121.6	8121.6	4665.6	2721.6
Net Income	6758	14438.4	14438.4	8294.4	4838.4

2) Non Cash Expense includes only depreciation

Year	1	2	3	4	5
Depreciation	2940	2940	2940	2940	2940
Total	2940	2940	2940	2940	2940

Note: All figures in ‘000

3) Increase in Working Capital:

Working capital = 15% of Sales

Therefore for 1^st Year, Increase in Working capital = 15% of Revenue = 3600 thousands

Therefore using current year Working capital – last year working capital, we can calculate the increase in working capital as follows:

Year	1	2	3	4	5
Increase in Working Capital	3600	3000	0	-2400	-4200

Year	1	2	3	4	5
Increase in Working Capital	3600	3000	0	-2400	-4200

Last year includes the liquidating all Working Capital

Therefore Sum of Working Capital = 0 to find 4200 thousands working capital has to be liquidated.

Therefore Free Cash flow:

Year	1	2	3	4	5
Net Income	6758	14438.4	14438.4	8294.4	4838.4
Non Cash Expense	2940	2940	2940	2940	2940
Increase in Working Capital	3600	3000	0	-2400	-4200
Free Cash Flow(Net Income + non-cash expenses – Increase in Working Capital – capex)	6098	14378.4	17378.4	13634.4	11978.4

Answer B

Free Cash flow,

Year 1 : 6,098,000

Year 2 :14,378,400

Year 3 : 17,378,400

Year 4:13,634,400

Answer C

Year 5: 11,978,400

Answer D

Now using answer of a, b & c

Below is the freecashflows:

Year	0	1	2	3	4	5
	-14980	6098	14378.4	17378.4	13634.4	11978.4

in '000s

Using NPV formula in Financial Calculator, with Rate of Return as 11%

NPV is

$27,910,650

Which is positive

Therefore Answer is A, Project should be selected.