Question

1. Your company is considering the purchase of Robinstats Inc. Robinstats is not publicly traded, so you need to discount its free cash flows to come up with a purchase price. You have the following information about Robinstats. Remember that all cash flows come at the end of the year. • Revenues are expected to be $6 million this year • Variable costs are expected to be $3 million this year • Fixed costs are expected to be $1.5 million this year • Revenues are expected to grow at 10% per year for two years (years 2 and 3) before settling into a constant growth of 3% per year forever • Variable costs are expected to grow at 3% per year forever • Fixed costs are expected to remain at $1.5 million per year forever • If you acquire Robinstats, you will inherit two years of depreciation write-offs of $500,000 per year (years 1 and 2). There is no risk associated with these write-offs, so discount the tax shield they create at the risk-free rate. • The marginal corporate tax rate is 21% • Your cost of capital is 12% • The risk-free rate is 3% What is the value of Robinstats Inc.?

2) Sustef Corporation is considering replacing a machine. The replacement will cut operating expenses by $24,000 per year for each of the five years the new machine is expected to last. Although the old machine has a remaining useful life of five years, it only has two years of depreciation left on its schedule ($10,000 per year). If the new machine is purchased, the old machine would be immediately sold for an amount equal to its book value. The new machine will cost $72,000 which will be depreciated over its expected life (no salvage value). Sustef is subject to a 21% tax rate on ordinary income and has a cost of capital of 12 percent. Calculate the NPV of replacing the old machine with the new one.

Answer 1

The figures have been taken in million only and depreciation tax shield has also been converted to million.

In 2nd question, in the first two years less depreciation is taken because in case of replacements, we take incremental cashflows only, therefore incremental depreciation has been taken.
willion) w year Year 2 6.6 Year 3 3.26 しいワンプアップ 3.18 IS tax 0.542 Revenuer - Variable 3.09 Cort - Fixed cast 1.5 15 Prefit before 1.5 &.01 -Tax Cal. 0.315 0.422 185 1.59 P.V.fant) 0.893 0.797 PV 1.06 1.27 +Poved olog 0.099 Dep tax shield Totalpv 1.208 | 126 HDepreciation Q.04 0.712 1.45 1,45 Year / 500000 x 21 /.xP.VE (39.: 101955 Year 2 Socoooxaly.xpVF(352) = 99015 RVF(30g) = 0.971 pVf(3..92) = 0.943 Year 4 リリリリリリン 66 Revenues 7.47 & P. V of Revenues at the end of yeal 3 7.26(1+0.03) = 83 012-0.03 vuof variable cost at the end of real 3 3,18(1+0.03) = 36.4 おは 0.12-0.03

P. V of fixed cost at the end of year B 1.5 = 12.5 0.12 Cash flow at the end of year 3. Revenues 83 - variable cost - 36.4 - Fixed cost - 12.5 Profit before Tax 34.1 - Tax @ 21% - 7.2 Profit after tax 26.9. Present value of the cash flow at Year o - 26.9 X PUF ( 3%, 12) = 26.9 0.712 - 19.18 Adding present values of all cash flows - 1.208+ 1.126+ 1.45+ 19.18 - 22.96 22.96 million is the value of Robinstate to I computation of incremental cash flows G Savings 24000 24000 24000 24000 24000 t - Depreciation 4400 4400 14400 144000 14400 e Savings before tat 19600 19600 19600 9600 9600 t Tax @ 21% 4116 4116 2016 2016 2016 e Savings after tax 15484 15484 7584 7584 7584 8 & Depreciation 4400 4400 14400 14400 144002 Cash flow 19884 19884 21984 21984 21984 €

- 0.893 0.797 0.712 0.636 PUF ( 12%, t) P.V of Cash flows 17756 15848 15653 13982 0.567 12465 - Sum of P.U = 75704 NPU- P.U of inflows - P. V of Cashout flows. 75704 - 72000 - 3704