Finance 1 Project Analysis Case Study Background and data You have been asked to consult for...

 

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Finance 1 Project Analysis Case Study Background and data You have been asked to consult for St. Thaddeus College, a small, Catholic, liberal arts, for- profit college in Gastonia that specializes in economics and aeronautics. St. Thaddeus College has identified an opportunity to open a new campus for art residencies on its property holdings in the mountains a few hours from campus. The project is expected to run for five years and its codename is Project Rose. The college originally purchased the land used for Project Rose for $200 in an 1884 bankruptcy sale and built a dorm and several academic buildings for $300,000 in 1927. The buildings were renovated for $430,000 in 1968, but they are not used for the colleges operations today. Rather, the college rents out these buildings for camps, small conferences, corporate training and retreats, generating a profit of $240,000 (after taxes) per year. The college will not be able to continue doing this for the duration of Project Rose, but expects to resume renting the buildings out after the project has concluded. Last year, the college commissioned a feasibility study for $175,000 to determine likely outcomes from the project. St. Thaddeus used the results of this study to develop the following projections for the five-year project. At the beginning of the project, St. Thaddeus will need to spend a total of $745,000 on equipment, building improvements, and gallery renovations. These capital expenditures will be depreciated according to the three-year MACRS schedule in Table 1. At the end of the project, the remaining capital equipment will be sold for $150,000 (before taxes). If the project is accepted, St. Thaddeus will need to increase accounts receivable and inventory by $170,000 and increase accounts payable by $90,000. At the end of the five-year project, net working capital will return to its pre-project level. During Project Rose, the college will have to hire a baseline level of additional professors and staff. With their salaries and other expenses, St. Thaddeus will incur $325,000 of fixed annual costs. The college expects to enroll 200 students in Project Rose in the first year. They expect that enrollment will grow by 25 students for each of the following three years. Each student will pay $24,000 per year in tuition, but they will generate $20,500 of annual costs for the college from the additional staffing requirements, purchase of art supplies, gallery exhibition fees, and other per-student expenses. St. Thaddeus College's required return for Project Rose is 9.0 %, and its tax rate is 21%. You have been contracted to analyze the merits of accepting Project Rose and submit a report to the president of St. Thaddeus College, Dr. Pak Dondin. You report should explain your analysis and recommendation of whether or not to accept this project based on the financial projections and your more general business/strategic evaluation. Projections are rarely perfect predictions of the future so your contract stipulates that your analysis should include an investigation into possible outcomes of the project and contingency plans in successful or less successful than expected. ase the new campus is more Deliverable (assignment details) Write a report detailing your analysis and recommendations to the president of St. Thaddeus College, Dr. Pak Dondin, and submit it on Canvas. Although Dr. Dondin is quite intelligent, he does not have a background in corporate finance, so your report should be readable by a layperson. Explain key terms and ideas where appropriate. You should include your relevant calculations as an appendix (i.e., an Excel worksheet - please make it look decent/easy to follow) Your analysis and report should address all of the following: . . What are the NPV and IRR for Project Rose based on the base case assumptions above? Should St. Thaddeus accept the project if these assumptions are accurate and complete? o Make sure to explain how you calculated NPV/IRR in the report (describe the process in words - don't go through every single calculation) and what these data values actually mean. In the feasibility study mentioned above, there are expected margins of error for the per- student cost and revenue estimates. The study claims that the even under normal circumstances, the revenue per student and annual cost per student are likely to vary by as much as ±7% from the estimates provided above. Based on these margins of error. calculate NPV and IRR under the best-case and worst-case scenarios. • One area of uncertainty for Project Rose is student enrollment. With your base case assumptions, what is the sensitivity of NPV to a one-student change in annual enrollment (i.e., change the number of initial students by 1, but continue the 25 per year growth)? o How many year 1 students are needed for Project Rose to have a positive NPV? o Ignoring TVM, what is the fewest number of year 1 students for Project Rose to at least break even on the project? (At the exact break-even point, IRR=0) If the project does start out with 200 year 1 students, what rate of annual enrollment growth is needed to maintain a positive NPV? A positive IRR? o The college would like to draw on your general business knowledge to identify potential side-effects, positive or negative, that might affect the feasibility of Project Rose. Specifically, are there any ways that launching Project Rose could affect the college's existing programs? o Identify and explain one possible positive side-effect and one possible negative side-effect. Explain how incorporating these possible side-effects would affect your cashflow/NPV calculation and overall recommendation? Use the preceding analysis and any other factors that you think are relevant to make an overall recommendation about whether to proceed with Project Rose. o Your answer might be conditional - something like "if the college can get more certainty about X then yes they should go ahead, but if not, then don't" - if you think it's a borderline case based on some particular variables/outcomes. Feel free to identify any other key questions or concerns that President Dondin should address before deciding on the project. Year 1 2 3 4 5 6 7 8 Table 1: MACRS schedule 3-Year 5-Year 7-Year 33.33% 20.00% 14.29% 44.45% 32.00% 24.49% 14.81% 19.20% 17.49% 7.41% 11.52% 12.49% 11.52% 8.93% 5.76% 8.92% 8.93% 4.46% Table 2: Project assumptions Assumption Initial capital investment cost Sale price of capital (pretax) After tax cash flow from sale Change to current assets in year 0 Change to current liabilities in year 0 Change to NWC in year 0 Ongoing Opportunity cost Value Assumption Year 1 student enrollment Enrollment growth per year Revenue per student Variable cost per student Fixed costs Tax rate Discount rate Value Basic Financial Data Units (students) Revenue Variable costs (VC #students) Fixed costs Total cost MACRS percent Depreciation Calculate OCF Revenue . - Total cost - Depreciation = EBIT - taxes = Net income Project financials worksheet/timeline template + Depreciation = OCF Calculate cash flow OCF CF from change in NWC (after tax) Capital cash flows Opportunity cost Total cash flow (CFFA) PV of total cash flow NPV IRR 0 0 1 1 1 2 2 2 3 3 3 4 4 4 Note: Do not copy & paste this straight into excel - the columns get weird formatting. It will be more trouble than the time you'd save from making the tables yourself. Copying just the first columns would probably be fine Also, you can calculate OCF the way it is shown in the table above or using the tax shield formula. 5 5 5 Finance 1 Project Analysis Case Study Background and data You have been asked to consult for St. Thaddeus College, a small, Catholic, liberal arts, for- profit college in Gastonia that specializes in economics and aeronautics. St. Thaddeus College has identified an opportunity to open a new campus for art residencies on its property holdings in the mountains a few hours from campus. The project is expected to run for five years and its codename is Project Rose. The college originally purchased the land used for Project Rose for $200 in an 1884 bankruptcy sale and built a dorm and several academic buildings for $300,000 in 1927. The buildings were renovated for $430,000 in 1968, but they are not used for the colleges operations today. Rather, the college rents out these buildings for camps, small conferences, corporate training and retreats, generating a profit of $240,000 (after taxes) per year. The college will not be able to continue doing this for the duration of Project Rose, but expects to resume renting the buildings out after the project has concluded. Last year, the college commissioned a feasibility study for $175,000 to determine likely outcomes from the project. St. Thaddeus used the results of this study to develop the following projections for the five-year project. At the beginning of the project, St. Thaddeus will need to spend a total of $745,000 on equipment, building improvements, and gallery renovations. These capital expenditures will be depreciated according to the three-year MACRS schedule in Table 1. At the end of the project, the remaining capital equipment will be sold for $150,000 (before taxes). If the project is accepted, St. Thaddeus will need to increase accounts receivable and inventory by $170,000 and increase accounts payable by $90,000. At the end of the five-year project, net working capital will return to its pre-project level. During Project Rose, the college will have to hire a baseline level of additional professors and staff. With their salaries and other expenses, St. Thaddeus will incur $325,000 of fixed annual costs. The college expects to enroll 200 students in Project Rose in the first year. They expect that enrollment will grow by 25 students for each of the following three years. Each student will pay $24,000 per year in tuition, but they will generate $20,500 of annual costs for the college from the additional staffing requirements, purchase of art supplies, gallery exhibition fees, and other per-student expenses. St. Thaddeus College's required return for Project Rose is 9.0 %, and its tax rate is 21%. You have been contracted to analyze the merits of accepting Project Rose and submit a report to the president of St. Thaddeus College, Dr. Pak Dondin. You report should explain your analysis and recommendation of whether or not to accept this project based on the financial projections and your more general business/strategic evaluation. Projections are rarely perfect predictions of the future so your contract stipulates that your analysis should include an investigation into possible outcomes of the project and contingency plans in successful or less successful than expected. ase the new campus is more Deliverable (assignment details) Write a report detailing your analysis and recommendations to the president of St. Thaddeus College, Dr. Pak Dondin, and submit it on Canvas. Although Dr. Dondin is quite intelligent, he does not have a background in corporate finance, so your report should be readable by a layperson. Explain key terms and ideas where appropriate. You should include your relevant calculations as an appendix (i.e., an Excel worksheet - please make it look decent/easy to follow) Your analysis and report should address all of the following: . . What are the NPV and IRR for Project Rose based on the base case assumptions above? Should St. Thaddeus accept the project if these assumptions are accurate and complete? o Make sure to explain how you calculated NPV/IRR in the report (describe the process in words - don't go through every single calculation) and what these data values actually mean. In the feasibility study mentioned above, there are expected margins of error for the per- student cost and revenue estimates. The study claims that the even under normal circumstances, the revenue per student and annual cost per student are likely to vary by as much as ±7% from the estimates provided above. Based on these margins of error. calculate NPV and IRR under the best-case and worst-case scenarios. • One area of uncertainty for Project Rose is student enrollment. With your base case assumptions, what is the sensitivity of NPV to a one-student change in annual enrollment (i.e., change the number of initial students by 1, but continue the 25 per year growth)? o How many year 1 students are needed for Project Rose to have a positive NPV? o Ignoring TVM, what is the fewest number of year 1 students for Project Rose to at least break even on the project? (At the exact break-even point, IRR=0) If the project does start out with 200 year 1 students, what rate of annual enrollment growth is needed to maintain a positive NPV? A positive IRR? o The college would like to draw on your general business knowledge to identify potential side-effects, positive or negative, that might affect the feasibility of Project Rose. Specifically, are there any ways that launching Project Rose could affect the college's existing programs? o Identify and explain one possible positive side-effect and one possible negative side-effect. Explain how incorporating these possible side-effects would affect your cashflow/NPV calculation and overall recommendation? Use the preceding analysis and any other factors that you think are relevant to make an overall recommendation about whether to proceed with Project Rose. o Your answer might be conditional - something like "if the college can get more certainty about X then yes they should go ahead, but if not, then don't" - if you think it's a borderline case based on some particular variables/outcomes. Feel free to identify any other key questions or concerns that President Dondin should address before deciding on the project. Year 1 2 3 4 5 6 7 8 Table 1: MACRS schedule 3-Year 5-Year 7-Year 33.33% 20.00% 14.29% 44.45% 32.00% 24.49% 14.81% 19.20% 17.49% 7.41% 11.52% 12.49% 11.52% 8.93% 5.76% 8.92% 8.93% 4.46% Table 2: Project assumptions Assumption Initial capital investment cost Sale price of capital (pretax) After tax cash flow from sale Change to current assets in year 0 Change to current liabilities in year 0 Change to NWC in year 0 Ongoing Opportunity cost Value Assumption Year 1 student enrollment Enrollment growth per year Revenue per student Variable cost per student Fixed costs Tax rate Discount rate Value Basic Financial Data Units (students) Revenue Variable costs (VC #students) Fixed costs Total cost MACRS percent Depreciation Calculate OCF Revenue . - Total cost - Depreciation = EBIT - taxes = Net income Project financials worksheet/timeline template + Depreciation = OCF Calculate cash flow OCF CF from change in NWC (after tax) Capital cash flows Opportunity cost Total cash flow (CFFA) PV of total cash flow NPV IRR 0 0 1 1 1 2 2 2 3 3 3 4 4 4 Note: Do not copy & paste this straight into excel - the columns get weird formatting. It will be more trouble than the time you'd save from making the tables yourself. Copying just the first columns would probably be fine Also, you can calculate OCF the way it is shown in the table above or using the tax shield formula. 5 5 5