Original Proposal: (all expected numbers are incremental)

Initial outlay = $ 10 million

Earnings Before Interest and Tax (end of year 1) = $1.5 million

Corporate Tax rate = 28%

Depreciation & Amortization = $ 1 million

Change in Current Assets = $100,000

Change in Current Liability = $70,000

Salvage value = NONE

Note: The projects initial outlay will be incurred RIGHT IN THE BEGINNING OF the first year (e.g. t = 0). For lack of better information, Mishra estimates that the actual first-year 4 cash inflow (e.g. t = 1) from the project will continue for the entire ten-year life.

However, being concerned about uncertainty around this new investment, Neena proposed another alternative to Dusty-rid that calls for a partnership (co-investment) with SVC. To mitigate the risk to SVC even further, Neena added to this alternate deal that Dusty-rid must provide SVC with an exit strategy. Specifically, after five years of the super-filter project, SVC can choose to sell the part of the project that it owns to Dusty-rid at a fixed price. Neena then asked Dusty-rid management to name the price. In a few days, Dusty-rid came back with the price as $3 million. Apparantly, the partnership alternative represents a smaller scale operation to SVC. Projected numbers based on this alternative itself are given as follows:

Alternative Proposal: (all expected numbers are incremental, and to SVC)

Initial outlay = $ 7 million

Earnings Before Interest and Tax (end of year 1) = $ 1,100,000

Corporate Tax rate = 28%

Depreciation & Amortization = $ 700,000

Change in Current Assets = $50,000

Change in Current Liability = $35,000

Salvage value = NONE

Other relevant pieces of information are given as follows:

- The discount rate that reflects the riskiness in air-conditioning industry is 9%

- The New Zealand 10 Year Government Bond yield is 4.38%

- The variance of share returns on renovation industry in New Zealand is 36%

- The decay rate can be assumed as equal in each year throughout the life of the project

- Lets use e = 2.71828

QUESTIONS

1. calculate the worth of each alternative accordingly. Please show workings (detail)

2. At what Exit price would the two alternatives be identical in their worths.

3. Write an Executive Summary to Neena to advise which alternative should be pursued by SVC. In the process, make use of numbers you calculated from Questions 1 and 2 for justifications. Also provide the points to be cautious about in your analysis.