Question

You work for Apple. After toiling away on $ 9.9 million worth of​ prototypes, you have finally produced your answer to Google​ Glasses: iGlasses​ (the name alone is​ genius). iGlasses will instantly transport the wearer into the world as Apple wants him to experience​ it: iTunes with the wink of an eye and apps that can be activated just by looking at them. You think that these will sell for five years until the next big thing comes along​ (or until users are unable to interact with actual human​ beings). Revenues are projected to be $ 455.3 million per year along with expenses of $ 357.4 million. You will need to spend $ 60.7 million immediately on additional equipment that will be depreciated using the​ 5-year MACRS schedule.​ Additionally, you will use some fully depreciated existing equipment that has a market value of $ 9.6 million. As the iGlasses are an outcome of the​ R&D center, Apple plans to charge $ 4.9 million of the annual costs of the center to the iGlasses product for four years.​ Finally, Apple's working capital levels will increase from their current level of $ 122.7 million to $ 135.5 million immediately. They will remain at the elevated level until year​ 4, when they will return to $ 122.7 million.​ Apple's discount rate for this project is 15.5 % and its tax rate is 35 %. Calculate the free cash flows and determine the NPV of this project.​ (*) The opportunity cost must be​ after-tax. Note​: Assume that the equipment is put into use in year 1.

Answer 1

Free Cash Flow or FCF represents the amount of cash generated by a business. It includes the operating cash flow, the capital expenditure, Proceedings from the asset sale and change of the working capitals. FCF is a commonly used measurement for understanding the profitability of a business.However it is also used to calculate the NPV of a project or business valuation.

Calculation of Free Cash Flow and NPV
Figures in $ mn
Particulars	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Sales		455.30	455.30	455.30	455.30	455.30
Less: Cost of Goods Sold		357.40	357.40	357.40	357.40	357.40
Gross Profit		97.90	97.90	97.90	97.90	97.90
Less: Annual Charge		4.90	4.90	4.90	4.90	-
Less: Depreciation		12.14	12.14	12.14	12.14	12.14
EBIT		80.86	80.86	80.86	80.86	85.76
Tax		28.30	28.30	28.30	28.30	30.02
PAT		52.56	52.56	52.56	52.56	55.74
Add: Depreciation		12.14	12.14	12.14	12.14	12.14
Less: Incremental W.Capital		12.80	-	-	-	-12.80
Less: Capital Investment	60.70
Less: Opportunity Cost	6.24
Incremental Free Cash Flow	-66.94	51.90	64.70	64.70	64.70	80.68
Discounting factor	1.00	0.87	0.75	0.65	0.56	0.49
Present Value	-66.94	44.93	48.50	41.99	36.36	39.25
Net Present Value	144.09