Question

Question 2 You are in charge of a company called Tuck New Ventures, and you are planning to set up a travel agency called Tuck Social Trek (TST) to arrange pleasure treks all around the world for business school students, faculty, and staff for the next three years (20167018) The office equipment for TST will be purchased at the end of 2015 for $300,000. To finance the purchase you will obtain a $200,000 kan at the annual interest of 6%, and the remaining $100,000 will be financed with cash. You expect that you will be able to sell the ofice equipment at the end of 2018 for $100,000. The IRS requires that the equipment is depreciated straight-line over three years to nero. TST is expected to seil 1,000 trips cach year (in 2016, 2017, & 2018) at the average price of $1,394 per trip. The average cost per trip is expected to be $1,061. In addition to these costs, the agency will incur labor costs of $124,000 per year. It will also pay a rent of $20,000 per year starting in 2016. (Assume no inflation.) Tuck New Ventures already has another travel agency that focuses on domestic trips and is open to general public. This old ageney is expected to lose about 300 trips per year to TST. The agency's average price per trip is $950 and the average cost per trip is $750. TST will maintain net working capital ofabout 10% of its revenues starting in 2016, Net working capital will be fully recovered at the end of 2018. The corporate tax rate is 35%. To obtain detailed estimates of the expected revenues and costs of the project, you hired a consultant a year ago. The consulting fee was S50,000 and was paid on 05/01/14. Estimate the free cash flow for the project. Please use the table on the next page.

Answer 1

Before we get into the numerical part, please note the following:

• We have been asked to calculate free cash flow for the project, hence we need to calculate unlevered cash flow without taking into impact the loan (or debt)
• The consulting fee was S50,000 and was paid on 05/01/14. This is a sunk cost and hence will not be relevant.

Please see the table below. Please be guided by the second column. That will explain how each row has been calculated.

Year	Linkage	2015	2016	2,017	2018
Purchase cost for equipment	A	(300,000)
Revenue	B = 1394 x 1000		1,394,000	1,394,000	1,394,000
Trip cost	C = -1061 x 1000		(1,061,000)	(1,061,000)	(1,061,000)
Labor costs	D		(124,000)	(124,000)	(124,000)
Rent	E		(20,000)	(20,000)	(20,000)
Revenue loss for old agency	F = -300 x 950		(285,000)	(285,000)	(285,000)
Cost saved for old agency	G = 300 x 750		225,000	225,000	225,000
Annual Depreciation	H = A / 3		(100,000)	(100,000)	(100,000)
Operating income	I = sum of all the line items above		29,000	29,000	29,000
Taxes	J = 35% x I		(10,150)	(10,150)	(10,150)
NOPAT	K = I - J		18,850	18,850	18,850
Add back depreciation	- H		100,000	100,000	100,000
Investment in working capital	L = 10% x (B + F)		(110,900)	-	110,900
Pre tax salvage value	M				100,000
Tax on gain on sale	N = 35% x M				(35,000)
Free Cash flows of the project	O = A + K + H + L + M + N	(300,000)	7,950	118,850	294,750