Wind Power Inc. builds and operates wind farms that generate electrical power using wind turbines. The firm
Question:
a. Calculate the project’s expected NPV and IRR, assuming that the cost of capital for the project is 15%, the firm faces a 30% marginal tax rate, it uses straight-line depreciation for the new investment over a three-year project life, and it has a zero salvage value.
b. Calculate the annual economic profits for the investment for years 1 through 3. What is the present value of the annual economic profit measures discounted using the project’s cost of capital? What potential problems do you see for the project?
c. Calculate the economic depreciation for the project and use it to calculate a revised economic profit measure following the procedure laid out in Table 7-8. What is the present value of all the revised economic profit measures when discounted using the project’s cost of capital? ( Hint: First, revise the initial NOPAT estimate from your answer to Exercise 7-3a by subtracting the economic depreciation estimate from project free cash flow calculated in Exercise 7-3a. Next, calculate the capital charge for each year based on invested capital less economic depreciation.) d. Using your analysis in answering Exercises 7-3b and c, calculate the return on in-vested capital (ROIC) for years 1 through 3 as the ratio of NOPAT for year t to in-vested capital for year t -1. Compare the two sets of calculations and discuss how the use of economic depreciation affects the ROIC estimate for the project.
Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important... Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... Free Cash Flow
Free cash flow (FCF) represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. Unlike earnings or net income, free cash flow is a measure of profitability that excludes the...
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Valuation The Art and Science of Corporate Investment Decisions
ISBN: 978-0133479522
3rd edition
Authors: Sheridan Titman, John D. Martin
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