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 12.4% to evaluate this project. Based on extensive​ research, it has prepared the incremental free cash flow projections shown below​ (in millions of​ dollars):

Year	0	​1-9	10
Revenues		102.5	102.5
Manufacturing Expenses​ (other than​ depreciation)		-33.8	-33.8
Marketing Expenses		-10.4	-10.4
Depreciation		-15.0	-15.0
EBIT		43.3	43.3
Taxes at 3535​%		-15.2	-15.2
Unlevered Net Income		28.1	28.1
Depreciation		+15.0	+15.0
Additions to Net Working Capital		-4.7	-4.7
Capital Expenditures	-149.7
Continuation Value			+12.4
Free Cash Flow	−149.7	38.4	50.8

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 8% higher than​ forecast? What is the NPV if revenues are 8% 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 3% 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 6%per year rather than by 3%​?

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?

Answer 1

a]

NPV is calculated using NPV function in Excel. NPV is $67.86 million

b]

If revenues are 8% higher than forecast, NPV is $97.49 million

If revenues are 8% lower than forecast, NPV is $38.24 million

c]

If revenues, manufacturing expenses and marketing expenses grow by 3% every year, NPV is $92.02 million

If revenues, manufacturing expenses and marketing expenses grow by 6% every year, NPV is $119.86 million

d]

NPV is calculated at each percentage from 5% to 30% using the NPV formula

NPV at 5% is $154.77 million

NPV at 6% is $140.18 million

This is plotted on a graph below :

The project has positive NPV from 5% to 22% rate