Chapter 6 Brealy Problems

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Renting out $ 100,000.

00
Inflation 4%
Initial project $ 1,200,000.00
Life of equipment 10
Annual Depreciation $ 120,000.00
Life of Project 8.00
Sold for 400,000.00 160,000.00 Gain
WC 0 350000 40,000.00 Tax on Gain
Yearly WC 10% Sales 1-7 360,000.00 Net Cah inflow from Sale of Equip
Sales 4,200,000.00
Growth in Sales 5%
Manufacturing Costs 90% Sales 1-7
Tax 25%
Cost of Capital 12%
NPV ???

0 1 2 3 4
Initial Investment $ 1,200,000.00
Annual Depreciation $ 120,000 $ 120,000 $ 120,000 $ 120,000
Accumulated Depreciaion $ 120,000 $ 240,000 $ 360,000 $ 480,000
Book Value $ 1,200,000 $ 1,080,000 $ 960,000 $ 840,000 $ 720,000
Terminal Value
WC $ 350,000 $ 420,000 $ 441,000 $ 463,050 $ 486,203
Change in WC $ 350,000 $ 70,000 $ 21,000 $ 22,050 $ 23,153
0 1 2 3 4
Sales 4,200,000 4,410,000 4,630,500 4,862,025
Manufacturing Costs 3,780,000 3,969,000 4,167,450 4,375,823
Rent 100,000 104,000 108,160 112,486
Depreciation $ 120,000 $ 120,000 $ 120,000 $ 120,000
EBIT 200,000 217,000 234,890 253,716
Tax 50,000 54,250 58,723 63,429
NOPAT 150,000 162,750 176,168 190,287
Add Depreciation $ 120,000 $ 120,000 $ 120,000 $ 120,000
OCF 270,000 282,750 296,168 310,287
CAPEX $ (1,200,000)
WC $ (350,000) $ (70,000) $ (21,000) $ (22,050) $ (23,153)
Terminal Value
FCF $ (1,550,000) $ 200,000 $ 261,750 $ 274,118 $ 287,135

NPV $ 218,707
Cah inflow from Sale of Equipment

5 6 7 8

$ 120,000 $ 120,000 $ 120,000 $ 120,000


$ 600,000 $ 720,000 $ 840,000 $ 960,000
$ 600,000 $ 480,000 $ 360,000 $ 240,000
360,000.00
$ 510,513 $ 536,038 $ 562,840
$ 24,310 $ 25,526 $ 26,802 $ 562,840
5 6 7 8
5,105,126 5,360,383 5,628,402 5,909,822
4,594,614 4,824,344 5,065,562 5,318,840
116,986 121,665 126,532 131,593
$ 120,000 $ 120,000 $ 120,000 $ 120,000
273,527 294,373 316,308 339,389
68,382 73,593 79,077 84,847
205,145 220,780 237,231 254,542
$ 120,000 $ 120,000 $ 120,000 $ 120,000
325,145 340,780 357,231 374,542

$ (24,310) $ (25,526) $ (26,802) $ 562,840


360,000
$ 300,835 $ 315,254 $ 330,429 $ 1,297,382
Year
0 1 2 3 4 5
Capital Investment 500,000
Accumulated Depreciation 100,000 200,000 300,000 400,000 500,000
Year-End Book Value 500,000 400,000 300,000 200,000 100,000 0
Working Capital 40,000 44,000 48,400 53,240 58,564 0
Total Book Value 540,000 444,000 348,400 253,240 158,564 0

Revenues 200,000 220,000 242,000 266,200 292,820


Costs 100,000 110,000 121,000 133,100 146,410
Depreciation 100,000 100,000 100,000 100,000 100,000
Pretax Profit 0 10,000 21,000 33,100 46,410
Taxes at 25% 0 2,500 5,250 8,275 11,603
Profit after Tax 0 7,500 15,750 24,825 34,808

Revenues 200,000 220,000 242,000 266,200 292,820


Costs -100,000 -110,000 -121,000 -133,100 -146,410
Tax on Operations 0 -2,500 -5,250 -8,275 -11,603
Cash Flow from Operations 100,000 107,500 115,750 124,825 134,808
Change in Working Capital -40,000 -4,000 -4,400 -4,840 -5,324 58,564
Capital Investment -500,000
Total Cash Flows after taxes -540,000 96,000 103,100 110,910 119,501 193,372
Discount Factor @ 15% 1 0.870 0.756 0.658 0.572 0.497
Present Value -540,000 83,478 77,958 72,925 68,325 96,140

NPV -141,173

0 1 2 3 4 5
Total Cash Flows after taxes (nominal) -540,000 96,000 103,100 110,910 119,501 193,372
Adjustment Factor for Real CF 1.000 0.909 0.826 0.751 0.683 0.621
Net Cash Flows (real) -540,000 87,273 85,207 83,328 81,621 120,068
Discount Factor @ 4.545% 1 0.956526 0.914942 0.875166 0.837118 0.800726
Present Value -540,000 83,479 77,959 72,926 68,326 96,142

NPV -141,168
Guandong Machinery is evaluating a new project to produce encapsulators.
The initial investment in plant and equipment is RMB 500,000. Sales of
encapsulators in year 1 are forecasted at RMB 200,000 and costs at RMB 100,000.
Both are expected to increase by 10% a year in line with inflation. Profits are taxed at
25%. Working capital in each year consists of inventories of raw materials and is
forecasted at 20% of sales in the following year. The project will last five years and
the equipment at the end of this period will have no further value. For tax purposes
the equipment can be depreciated straight-line over these five years. If the nominal
discount rate is 15%, show that the net present value of the
project is the same whether calculated using real cash flows or nominal flows. The
renminbi (RMB) is the Chinese currency.
000's
year
0 1 2 3 4 5
Capital Investment 6,000 500
Accumulated Depreciation 1,200 2,400 3,600 4,800 6,000
Year-End Book Value 6,000 4,800 3,600 2,400 1,200 0
Working Capital 200 240 400 400 240 0
Total Book Value 6,200 5,040 4,000 2,800 1,440 0

Revenues 2000 2400 4000 4000 2400


Costs 500 600 1000 1000 600
Depreciation 1,200 1,200 1,200 1,200 1,200
Pretax Profit (includes DI in
300 600 1,800 1,800 1,100
Year 5)
Taxes at 25% 75 150 450 450 275
Profit after Tax 225 450 1,350 1,350 825

Revenues 2,000 2,400 4,000 4,000 2,400


Costs (500) (600) (1,000) (1,000) (600)
Tax on Operations (75) (150) (450) (450) (275)
Cash Flow from Operations 1,425 1,650 2,550 2,550 1,525
Change in Working Capital (200) (40) (160) 0 160 240
Capital Investment and DI (6,000) 500
Net Cash Flows (6,200) 1,385 1,490 2,550 2,710 2,265
Discount Factor @ 12% 1 0.893 0.797 0.712 0.636 0.567
Present Value (6,200) 1,237 1,188 1,815 1,722 1,285

NPV 1,047

0 1 2 3 4 5
Capital Investment 6,000 -500
Accumulated Depreciation 1,200 2,400 3,600 4,800 6,000
Year-End Book Value 6,000 4,800 3,600 2,400 1,200 0
Working Capital 200 240 400 400 240 0
Total Book Value 6,200 5,040 4,000 2,800 1,440 0

Unit Sales 500 600 1,000 1,000 600


Revenues 2000 2400 4000 4000 2400
Costs 500 600 1000 1000 600
Depreciation 1,200 1,200 1,200 1,200 1,200
Pretax Profit 300 600 1,800 1,800 600
Taxes at 25% 75 150 450 450 150
Profit after Tax 225 450 1,350 1,350 450

Revenues 2,000 2,400 4,000 4,000 2,400


Costs (500) (600) (1,000) (1,000) (600)
Tax on Operations (75) (150) (450) (450) (150)
Cash Flow from Operations 1,425 1,650 2,550 2,550 1,650
Change in Working Capital (200) (40) (160) 0 160 240
Capital Investment and DI (6,000) 500
tax on DI (125)
Net Cash Flows (6,200) 1,385 1,490 2,550 2,710 2,265
Discount Factor @ 12% 1 0.893 0.797 0.712 0.636 0.567
Present Value (6,200) 1,237 1,188 1,815 1,722 1,285

NPV 1,047
Better Mousetrap’s research laboratories have developed a new trap. The project requires an initial
investment in plant and equipment of $6 million. This investment will be depreciated straight-line over five
years to a value of zero, but when the project comes to an end at the end of five years, the equipment will,
in fact, be sold for $500,000. The firm believes that working capital at each date must be maintained at
10% of next year’s forecasted sales starting immediately. Production costs are estimated at 25% of
revenues. (There are no marketing expenses.) Sales forecasts are given in the following table. The firm
pays tax at 25% and the required return on the project is 12%. What is the NPV?
Capital Expenditure 4,000,000,000
Project Life 5 years
Real Salvage Value 500,000,000 Nominal Salvage Value 638,140,781
Number of Units 100,000
Selling Price Year 1 65,000 Growth In Price 4%
Raw Material 18,000 Growth in Cost 3%
Labor Cost 1,100,000,000 Growth in Labor 7%
Opportunity Cost of Renting Land 300,000,000 beginning of each period
Discount Rate 12%
Inflation 5%
Straight line method 5 years
Tax Rate 25%

year 0 Year 1 year 2


Deprecitaion Expense 672,371,844 672,371,844
Selling Prices 65,000 67600
Raw Material 18,000 18540
Labor Cost 1,100,000,000 1,177,000,000

year 0 Year 1 year 2


Capital Investment 4,000,000,000
Accumulated Depreciation
Year-End Book Value 4,000,000,000
Working Capital
Total Book Value 4,000,000,000

Revenues 6,500,000,000 6,760,000,000


raw Material Costs 1,800,000,000 1,854,000,000
Labor Cost 1,100,000,000 1,177,000,000
Depreciation 672,371,844 672,371,844
Rent of Land 300,000,000 300,000,000 300,000,000
Pretax Profit (300,000,000) 2,627,628,156 2,756,628,156
Taxes at 25% (75,000,000) 656,907,039 689,157,039
Profit after Tax (225,000,000) 1,970,721,117 2,067,471,117

Revenues 6,500,000,000 6,760,000,000


Material Costs 1,800,000,000 1,854,000,000
Labor Cost 1,100,000,000 1,177,000,000
Rent 300,000,000 300,000,000 300,000,000
Tax on Operations 656,907,039 689,157,039
Cash Flow from Operations (300,000,000) 2,643,092,961 2,739,842,961
Change in Working Capital
Capital Investment and DI (4,000,000,000)
Terminal Value
Net Cash Flows (4,300,000,000) 2,643,092,961 2,739,842,961
Discount Factor @ 12%
Present Value (4,300,000,000) 2,359,904,429 2,184,186,034
NPV 6,351,726,028.83
Year 3 Year 4 Year 5
672,371,844 672,371,844 672,371,844
70304 73116 76041
19096 19669 20259
1,259,390,000 1,347,547,300 1,441,875,611

Year 3 Year 4 Year 5

7,030,400,000 7,311,616,000 7,604,080,640


1,909,620,000 1,966,908,600 2,025,915,858
1,259,390,000 1,347,547,300 1,441,875,611
672,371,844 672,371,844 672,371,844
300,000,000 300,000,000
2,889,018,156 3,024,788,256 3,463,917,327
722,254,539 756,197,064 865,979,332
2,166,763,617 2,268,591,192 2,597,937,995

7,030,400,000 7,311,616,000 7,604,080,640


1,909,620,000 1,966,908,600 2,025,915,858
1,259,390,000 1,347,547,300 1,441,875,611
300,000,000 300,000,000
722,254,539 756,197,064 865,979,332
2,839,135,461 2,940,963,036 3,270,309,839

638,140,781
2,839,135,461 2,940,963,036 3,908,450,620

2,020,840,542 1,869,035,177 2,217,759,846


New Line 1000000
life 5 years Depreciation Rate
MACRS 3 years Depreciation expense
Sold for 200000 Year 5 dollars Accumulated Depreciation
Savings 40000 per year todays dollars BV
Additional Net Cash flows before Tax 60000 todays dollars
Investment in WC 10000
Tax Rate 0.35 Discount Rate 0.1
Inflation 0.03
NPV?
0 1 2 3
Additional NCF before Tax adjusted to Inflation $ 61,800 $ 63,654 $ 65,564
Savings Adjusted to inflation $ 41,200 $ 42,436 $ 43,709
Subtotal $ 103,000 $ 106,090 $ 109,273
Tax $ 36,050 $ 37,132 $ 38,245
NOPAT $ 66,950 $ 68,959 $ 71,027
Add: Depreciation Tax Shield 116655 155750 51800
OCF $ 183,605 $ 224,709 $ 122,827
CAPEX $ (1,000,000)
Investment in WC $ (10,000)
FCF $ (1,010,000) $ 183,605 $ 224,709 $ 122,827
NPV $ (363,719.77)
0 1 2 3 4 5
preciation Rate 0.3333 0.445 0.148 0.074
preciation expense 333300 445000 148000 74000
cumulated Depreciation 333300 778300 926300 1000300
-300

4 5
$ 67,531 $ 69,556
$ 45,020 $ 46,371
$ 112,551 $ 115,927
$ 39,393 $ 40,575
$ 73,158 $ 75,353
25900 0
$ 99,058 $ 75,353
130000
$ 10,000
$ 99,058 $ 215,353
50000 72000
10 15
Annual Operating Cost 5000 4800
Cost of Capital 0.1
EAC
EAC $80,722.84 6.1446 $13,137.2697
EAC $108,509.18 7.6061 $14,266.11

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