Question 6 [15 points] Today is January 1, 2024. You are helping Enrico make 10-year cash...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
Question 6 [15 points] Today is January 1, 2024. You are helping Enrico make 10-year cash flow projections for an IT project. The cost of financing for the project can be inferred from the following data. Analysts estimate that the cost of debt for the IT project will be approximately 4.2%. The projected beta of equity for the project is 1.1, and the firm is planning to maintain a constant debt-to-equity ratio (in market values) of 0.40. Using expert forecasts for stock market returns, you believe that the annual expected return for the entire market will be 8% for the next 10 years, and that the risk-free rate will be projected to remain at 4% over the entire life of the project. Assume a marginal tax rate of 25%, and that any tax loss can be carried forward indefinitely. The project will have various investment needs. For example, the machinery needed for the project costs $4 million, and according to the tax authority, is depreciated using the straight line method over ten years. You can operate the machinery for 10 years. The pre- tax salvage value of the machinery at the end of the 10 years is expected to be $500,000. The purchase of the machinery is made today. You also expect to incur additional capital expenditures of $1.2 million for new equipment on December 31, 2030. This equipment is depreciated using the straight line method over the remaining life of the project, and is not expected to have any salvage value. The revenues from the project are expected to be $40 million first starting on December 31, 2024, and are expected to grow at a rate of 4% per year. Labor is expected to cost approximately $1.2 million every year, while COGS are estimated to be 10% of revenues each year. The net working capital required for the project is given by the following data: Days sales outstanding will be 30 days (out of a 360 day cycle) and based entirely on annual revenues, while days payable outstanding will be 45 days (out of a 360 day cycle), and will only be relevant for labor costs (not for COGS or any other expenses). Inventory will be 6% of COGS each year. Assume net working capital is 0 as of today, and fully recovered by the end of the project (on December 31, 2033). Also assume that straight-line depreciation is calculated in the following way (for all problems in this assignment): Annual depreciation expense = (Purchase price-Salvage value)/# years of useful life, for a given production asset. a) Please forecast the free cash flows for the project. b) Please calculate the weighted average cost of capital for the project. c) Suppose the firm were to implement a plan that would enable it to receive cash from sales at a faster rate. If the firm could reduce its days sales outstanding by half every year (i.e. from 30 days to 15 days), how much would the NPV of the project change? What's the intuition for the change that you calculate? d) If the firm wished to realize the same increase in NPV by increasing its days payable outstanding by x% each year, what would x be? (Assume days sales is back to the original 30 days). If there is no solution to this problem, please explain why. 6C Labour cost 1.20 1.20 1.20 1.20 1.20 1.20 1.20 1.20 1.20 1.20 COGS 4.00 4.16 4.33 4.50 4.68 4.87 5.06 5.26 5.47 5.69 Depreciation machine 1 Depreciation machine 2 0.35 0.35 0.35 0.35 0.35 0.35 0.35 0.35 0.35 0.35 0.30 0.30 0.30 0.30 capital gain/salvage value 0.50 EBIT 34.45 35.89 37.39 38.95 40.56 42.25 43.70 45.52 47.42 49.89 FCF 0 1 2 3 4 5 6 7 8 9 10 EBIT(1-tax) tax @25% 25.84 26.92 28.04 29.21 30.42 31.69 32.78 34.14 35.56 37.42 add depreciation 0.35 0.35 0.35 0.35 0.35 0.35 0.65 0.65 0.65 0.65 less CAPEX 4 1.20 less change in NWC 3.42 0.14 0.15 0.15 0.16 0.17 0.17 0.18 0.19 -4.74 FCF -4 22.76 27.12 28.24 29.40 30.61 30.67 33.25 34.61 36.03 42.81 PV(FCF) -4 21.29482 23.73599 23.11868 22.5164 21.92885 20.55163 20.84379 20.29563 19.76123 21.96547 Sum of PV 212.0125 With accounts r NWC year 1 2 3 4 5 6 7 8 9 10 account payables 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 Account receivables 1.67 1.73 1.80 1.87 1.95 2.03 2.11 2.19 2.28 2.37 Inventory 0.24 0.25 0.26 0.27 0.28 0.29 0.30 0.32 0.33 0.34 WC 0 1.76 1.83 1.91 1.99 2.08 2.17 2.26 2.36 2.46 0.00 change in WC 1.76 0.08 0.08 0.08 0.09 0.09 0.09 0.10 0.10 -2.46 FCF 2 3 4 5 6 7 8 10 EBIT(1-tax) tax @25% 25.84 26.92 28.04 29.21 30.42 31.69 32.78 34.14 35.56 37.42 add depreciation less CAPEX 0.35 0.35 0.35 0.35 0.35 0.35 0.65 0.65 0.65 0.65 1.20 less change in NWC 1.76 0.08 0.08 0.08 0.09 0.09 0.09 0.10 0.10 -2.46 FCF PV(FCF) Sum of PV Change in NPV -4 -4 212.8259 24.43 27.19 28.31 29.48 30.69 30.75 33.33 34.70 36.11 40.53 22.85391 23.79433 23.17544 22.57162 21.98257 20.6039 20.89463 20.3451 19.80935 20.79506 0.813396 Question 6 [15 points] Today is January 1, 2024. You are helping Enrico make 10-year cash flow projections for an IT project. The cost of financing for the project can be inferred from the following data. Analysts estimate that the cost of debt for the IT project will be approximately 4.2%. The projected beta of equity for the project is 1.1, and the firm is planning to maintain a constant debt-to-equity ratio (in market values) of 0.40. Using expert forecasts for stock market returns, you believe that the annual expected return for the entire market will be 8% for the next 10 years, and that the risk-free rate will be projected to remain at 4% over the entire life of the project. Assume a marginal tax rate of 25%, and that any tax loss can be carried forward indefinitely. The project will have various investment needs. For example, the machinery needed for the project costs $4 million, and according to the tax authority, is depreciated using the straight line method over ten years. You can operate the machinery for 10 years. The pre- tax salvage value of the machinery at the end of the 10 years is expected to be $500,000. The purchase of the machinery is made today. You also expect to incur additional capital expenditures of $1.2 million for new equipment on December 31, 2030. This equipment is depreciated using the straight line method over the remaining life of the project, and is not expected to have any salvage value. The revenues from the project are expected to be $40 million first starting on December 31, 2024, and are expected to grow at a rate of 4% per year. Labor is expected to cost approximately $1.2 million every year, while COGS are estimated to be 10% of revenues each year. The net working capital required for the project is given by the following data: Days sales outstanding will be 30 days (out of a 360 day cycle) and based entirely on annual revenues, while days payable outstanding will be 45 days (out of a 360 day cycle), and will only be relevant for labor costs (not for COGS or any other expenses). Inventory will be 6% of COGS each year. Assume net working capital is 0 as of today, and fully recovered by the end of the project (on December 31, 2033). Also assume that straight-line depreciation is calculated in the following way (for all problems in this assignment): Annual depreciation expense = (Purchase price-Salvage value)/# years of useful life, for a given production asset. a) Please forecast the free cash flows for the project. b) Please calculate the weighted average cost of capital for the project. c) Suppose the firm were to implement a plan that would enable it to receive cash from sales at a faster rate. If the firm could reduce its days sales outstanding by half every year (i.e. from 30 days to 15 days), how much would the NPV of the project change? What's the intuition for the change that you calculate? d) If the firm wished to realize the same increase in NPV by increasing its days payable outstanding by x% each year, what would x be? (Assume days sales is back to the original 30 days). If there is no solution to this problem, please explain why. 6C Labour cost 1.20 1.20 1.20 1.20 1.20 1.20 1.20 1.20 1.20 1.20 COGS 4.00 4.16 4.33 4.50 4.68 4.87 5.06 5.26 5.47 5.69 Depreciation machine 1 Depreciation machine 2 0.35 0.35 0.35 0.35 0.35 0.35 0.35 0.35 0.35 0.35 0.30 0.30 0.30 0.30 capital gain/salvage value 0.50 EBIT 34.45 35.89 37.39 38.95 40.56 42.25 43.70 45.52 47.42 49.89 FCF 0 1 2 3 4 5 6 7 8 9 10 EBIT(1-tax) tax @25% 25.84 26.92 28.04 29.21 30.42 31.69 32.78 34.14 35.56 37.42 add depreciation 0.35 0.35 0.35 0.35 0.35 0.35 0.65 0.65 0.65 0.65 less CAPEX 4 1.20 less change in NWC 3.42 0.14 0.15 0.15 0.16 0.17 0.17 0.18 0.19 -4.74 FCF -4 22.76 27.12 28.24 29.40 30.61 30.67 33.25 34.61 36.03 42.81 PV(FCF) -4 21.29482 23.73599 23.11868 22.5164 21.92885 20.55163 20.84379 20.29563 19.76123 21.96547 Sum of PV 212.0125 With accounts r NWC year 1 2 3 4 5 6 7 8 9 10 account payables 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 Account receivables 1.67 1.73 1.80 1.87 1.95 2.03 2.11 2.19 2.28 2.37 Inventory 0.24 0.25 0.26 0.27 0.28 0.29 0.30 0.32 0.33 0.34 WC 0 1.76 1.83 1.91 1.99 2.08 2.17 2.26 2.36 2.46 0.00 change in WC 1.76 0.08 0.08 0.08 0.09 0.09 0.09 0.10 0.10 -2.46 FCF 2 3 4 5 6 7 8 10 EBIT(1-tax) tax @25% 25.84 26.92 28.04 29.21 30.42 31.69 32.78 34.14 35.56 37.42 add depreciation less CAPEX 0.35 0.35 0.35 0.35 0.35 0.35 0.65 0.65 0.65 0.65 1.20 less change in NWC 1.76 0.08 0.08 0.08 0.09 0.09 0.09 0.10 0.10 -2.46 FCF PV(FCF) Sum of PV Change in NPV -4 -4 212.8259 24.43 27.19 28.31 29.48 30.69 30.75 33.33 34.70 36.11 40.53 22.85391 23.79433 23.17544 22.57162 21.98257 20.6039 20.89463 20.3451 19.80935 20.79506 0.813396
Expert Answer:
Related Book For
Income Tax Fundamentals 2013
ISBN: 9781285586618
31st Edition
Authors: Gerald E. Whittenburg, Martha Altus Buller, Steven L Gill
Posted Date:
Students also viewed these finance questions
-
You are making four-year cash flow projections for a restaurant chain. Analysts estimate that the typical cost of debt for the industry is approximately 6%. The projected equity beta for the project...
-
Since Ryanair DAC's2 emergence as an upstart challenger to the Aer Lingus Ltd.-British Airways plc duopoly in the late 1980s, it had been both a consumer champion and antagonist; a technological...
-
Soft Glow, Inc. manufactures light bulbs. Their purchasing policy requires that the purchasing agents place each quarter's purchasing requirements out for bid. This is because the Purchasing...
-
Allen Air Lines must liquidate some equipment that is being replaced. The equipment originally cost $12 million, of which 75% has been depreciated. The used equipment can be sold today for $4...
-
Simon Companys year-end balance sheets follow. (1) Express the balance sheets in common-size percents. Round percents to one decimal. (2) Assuming annual sales have not changed in the last three...
-
Identify the four components of an ecosystem. After you do this try to visualize the interactions of these four components of an ecosystem as illustrated by Figure 2. 2 in the textbook. Does this...
-
(Securities and Exchange Commission) The U.S. Securities and Exchange Commission (SEC) was created in 1934 and consists of five commissioners and a large professional staff. The SEC professional...
-
State suitable case for each model Hierarchical Model Network data model Relational model Object-oriented data model
-
State two factors that should be controlled in manufacturing a cylindrical container of uniform thickness, which should normally be in a standing position. Explain in detailed.
-
Suppose Garageband.com has a 28% cost of equity capital and a 10% cost of debt capital. The firm's debt-to-equity ratio is 1.5. Garageband is interested in investing in a telecomm project that will...
-
In a particular population of moths, the frequency of the DD genotype (dark) occurring in the population is 0.04. What is the frequency of the dd genotype (light) occurring in the population?
-
Using the event budget information listed below, determine the total ticket sales you need to break even while also earning the desired profit of $1,912? Revenue Registration fee: $130 per person...
-
Use the passbook below to answer the question. Account 0000000004 Balance $389.00 Narne Ken Ritter Date Deposit Withdrawal Interest 1/02/06 $389.00 2/05./06 3/0206 $122.33 402.06 4/15.06 5/06.06...
-
Elizabeth determined that her tax liability was $3,954. Her employer withheld $3,476 from her paychecks during the year. Elizabeth's tax return would show: A. tax due of $3,954. B. refund of $3,476....
-
Show that if x is a nonzero column vector in R n , then the n n matrix A= I n (2 /x 2 ).xx T is both orthogonal and symmetric.
-
Which of the ocean zones shown would be home to each of the following organisms: lobster, coral, mussel, porpoise, and dragonfish? For those organisms you identify as living in the pelagic...
-
Mary paid $2,000 of state income taxes in 2012. The total sales tax she paid during 2012 was $5,500, which included $3,000 for the cost of a new car. How should Mary treat the taxes paid on her 2012...
-
Janie graduates from high school in 2012 and enrolls in college in the fall. Her parents pay $4,000 for her tuition and fees. a. Assuming Janie's parents have AGI of $170,000, what is the American...
-
Yolanda is a cash basis taxpayer with the following transactions during the year: Cash received from sales of products........................................................................$65,000...
-
W hat is diauxic growth? Explain the roles of cAMP and CAP in this process.
-
What is antisense RNA? How does it affect the translation of a complementary mRNA?
-
List and describe three general ways that the functions of transcription factors can be modulated.
Study smarter with the SolutionInn App