Question

Bauer Industries is an automobile manufacturer. Management is currently evaluating a proposal to build a plant that will manufacture lightweight trucks. Bauer plans to use a cost of capital of 11.8 % to evaluate this project. Based on extensive​ research, it has prepared the following incremental free cash flow projections​ (in millions of​ dollars): .

a. For this​ base-case scenario, what is the NPV of the plant to manufacture lightweight​ trucks?

b. Based on input from the marketing​ department, Bauer is uncertain about its revenue forecast. In​ particular, management would like to examine the sensitivity of the NPV to the revenue assumptions. What is the NPV of this project if revenues are 12 % higher than​ forecast? What is the NPV if revenues are 12 % lower than​ forecast?

c. Rather than assuming that cash flows for this project are​ constant, management would like to explore the sensitivity of its analysis to possible growth in revenues and operating expenses.​ Specifically, management would like to assume that​ revenues, manufacturing​ expenses, and marketing expenses are as given in the table for year 1 and grow by 2 % per year every year starting in year 2. Management also plans to assume that the initial capital expenditures​ (and therefore​ depreciation), additions to working​ capital, and continuation value remain as initially specified in the table. What is the NPV of this project under these alternative​ assumptions? How does the NPV change if the revenues and operating expenses grow by 5 % per year rather than by 2 % ​?

d. To examine the sensitivity of this project to the discount​ rate, management would like to compute the NPV for different discount rates. Create a​ graph, with the discount rate on the x​-axis and the NPV on the y​-axis, for discount rates ranging from 5 % to 30 % . For what ranges of discount rates does the project have a positive​ NPV?

Year	0	1-9	10
Revenues		101	101
Manufacturing Expenses (other than depreciation)		-33.4	-33.4
Marketing Expenses		-9.6	-9.6
Depreciation		-15.5	-15.5
EBIT		42.5	42.5
Taxes at 34%		-14.45	-14.45
Unlevered Net Income		28.05	28.05
Depreciation		15.5	15.5
Additions to Net Working Capital		-4.5	-4.5
Capital Expenditures	-155
Continuation Value			11.5
Free Cash Flow	-155	39.05	50.55

Answer 1

Sol (a)
Year	Cash Flows	DF @ 11.8%	PV of CF
0	-155	1.000	-155.000
1	39.05	0.894	34.928
2	39.05	0.800	31.242
3	39.05	0.716	27.944
4	39.05	0.640	24.995
5	39.05	0.573	22.357
6	39.05	0.512	19.997
7	39.05	0.458	17.887
8	39.05	0.410	15.999
9	39.05	0.366	14.310
10	50.55	0.328	16.569
NPV of the plant to manufacture light weight trucks			71.229

Sol (d) Discount Rate and NPV is invertionally proportional thus kindly refer to the table below and plot the graph in the excel

Discount Rate	NPV
5%	153.594
10%	89.379
15%	43.826
20%	10.573
25%	-14.337
30%	-33.441

Sol (b) For 12% increase in sales the following NPV table is worked out:

Year	Cash Flows	DF @ 11.8%	PV of CF
0	-155	1.000	-155.000
1	43.10	0.894	38.554
2	43.10	0.800	34.485
3	43.10	0.716	30.845
4	43.10	0.640	27.590
5	43.10	0.573	24.678
6	43.10	0.512	22.073
7	43.10	0.458	19.743
8	43.10	0.410	17.660
9	43.10	0.366	15.796
10	54.60	0.328	17.898
NPV of the plant to manufacture light weight trucks			94.321

For 12% decrease in sales following NPV table is worked:

Year	Cash Flows	DF @ 11.8%	PV of CF
0	-155	1.000	-155.000
1	35.00	0.894	31.303
2	35.00	0.800	27.999
3	35.00	0.716	25.044
4	35.00	0.640	22.400
5	35.00	0.573	20.036
6	35.00	0.512	17.921
7	35.00	0.458	16.030
8	35.00	0.410	14.338
9	35.00	0.366	12.825
10	46.50	0.328	15.241
NPV of the plant to manufacture light weight trucks			48.136

Sol (c) For 2% change in revenues and operating expenses following NPV table is worked out:

Year	Cash Flows	DF @ 11.8%	PV of CF
0	-155	1.000	-155.000
1	39.05	0.894	34.928
2	39.82	0.800	31.854
3	40.60	0.716	29.051
4	41.39	0.640	26.495
5	42.21	0.573	24.164
6	43.03	0.512	22.038
7	43.88	0.458	20.099
8	44.74	0.410	18.331
9	45.62	0.366	16.718
10	58.02	0.328	19.017
NPV of the plant to manufacture light weight trucks			87.695

For 5% change in Revenues and Operating expenses following NPV table is worked out:

Year	Cash Flows	DF @ 11.8%	PV of CF
0	-155	1.000	-155.000
1	39.05	0.894	34.928
2	40.96	0.800	32.773
3	42.97	0.716	30.752
4	45.08	0.640	28.857
5	47.30	0.573	27.080
6	49.63	0.512	25.413
7	52.07	0.458	23.850
8	54.63	0.410	22.383
9	57.33	0.366	21.008
10	71.65	0.328	23.487
NPV of the plant to manufacture light weight trucks			115.532