fin 321 midterm review problems - capital budgeting, dcf valuation

8/10/2019 Fin 321 Midterm Review Problems - Capital Budgeting, DCF Valuation

1/27

NPV 2,862,082$

Initial

Sales forecast (units per year) 50,000 50,000

Product life (years) 4 4

Expected wholesale price ($ unit) 260 260Production cost ($ unit) 110 110

Selling, General and Administrative Costs ($ per year) 2,800,000 2,800,000

New equipment cost ($) 7,500,000 7,500,000

Years of depreciation 5 5

tax rate 40% 40%

Receivables (% of sales) 15% 15%

Payables (% of COGS) 15% 15%

WACC 12% 12%

Item Formula Year

Incremental Revenue =50000*260

Production Costs =-50000*110

Selling, General and Administrative Costs

Depreciation =-7500000/5

Incremental Cost

Incremental EBIT

Tax, 40% =EBIT*40%

Incremental Earnings

Receivables =15%*Sales

Payables =15%*COGS

Net Working Capital

Change in Net Working Capital

Add back Depreciation

Purchase Equipment

Incremental Free Cash Flow

WACC = 12%

Present Value of FCF

NPV

Comments:


2/27

- Even though the project lasts for 4 years, the equipment has a 5-year life, so we must account fo

- Negative EBIT provides a tax credit => has positive impact on after-tax earnings and cash flows a

- Why do we ignore interest expenses?


3/27

worst case best case

35,000 65,000

4 4

240 280120 100

2,800,000 2,800,000

7,500,000 7,500,000

5 5

40% 40%

15% 15%

15% 15%

15% 10%

0 1 2 3 4 5

13,000,000$ 13,000,000$ 13,000,000$ 13,000,000$

(5,500,000)$ (5,500,000)$ (5,500,000)$ (5,500,000)$

(2,800,000)$ (2,800,000)$ (2,800,000)$ (2,800,000)$

(1,500,000)$ (1,500,000)$ (1,500,000)$ (1,500,000)$ (1,500,000)$

(9,800,000)$ (9,800,000)$ (9,800,000)$ (9,800,000)$ (1,500,000)$

3,200,000$ 3,200,000$ 3,200,000$ 3,200,000$ (1,500,000)$

(1,280,000)$ (1,280,000)$ (1,280,000)$ (1,280,000)$ 600,000$

1,920,000$ 1,920,000$ 1,920,000$ 1,920,000$ (900,000)$

1,950,000$ 1,950,000$ 1,950,000$ 1,950,000$

(825,000)$ (825,000)$ (825,000)$ (825,000)$

1,125,000$ 1,125,000$ 1,125,000$ 1,125,000$

(1,125,000)$ -$ -$ -$ 1,125,000$

1,500,000$ 1,500,000$ 1,500,000$ 1,500,000$ 1,500,000$

(7,500,000)$

(7,500,000)$ 2,295,000$ 3,420,000$ 3,420,000$ 3,420,000$ 1,725,000$

(7,500,000)$ 2,049,107$ 2,726,403$ 2,434,288$ 2,173,472$ 978,811$

2,862,082$


4/27

r the final depreciation charge in the 5th year.

long as long as the firm has other profitable projects


5/27

2,862,082$

0 (10,439,881)$

5000 (9,109,685)$

10000 (7,779,489)$

15000 (6,449,292)$

20000 (5,119,096)$25000 (3,788,900)$

30000 (2,458,703)$

35000 (1,128,507)$

40000 201,689$

45000 1,531,886$

50000 2,862,082$

55000 4,192,278$

60000 5,522,474$

65000 6,852,671$

70000 8,182,867$

75000 9,513,063$

2,862,082$

180 (4,232,298)$

190 (3,345,501)$

200 (2,458,703)$

210 (1,571,906)$

220 (685,108)$

230 201,689$

240 1,088,487$

250 1,975,284$260 2,862,082$

270 3,748,879$

280 4,635,677$

2,862,082$

80 5,522,474$85 5,079,076$

90 4,635,677$

95 4,192,278$

100 3,748,879$

105 3,305,481$

110 2,862,082$

115 2,418,683$

120 1,975,284$

$(15,000,000)

$(10,000,000)

$(5,000,000)

$-

$5,000,000

$10,000,000

$15,000,000

0

5,0

00

10,0

00

15,0

00

20,0

00

25,0

00

30,0

00

NPV as fun

$(5,000,000)

$(4,000,000)

$(3,000,000)

$(2,000,000)

$(1,000,000)

$-$1,000,000

$2,000,000

$3,000,000

$4,000,000

$5,000,000

$6,000,000

180

190

200

210

220

NPV as function

$3,000,000

$4,000,000

$5,000,000

$6,000,000

NPV as function


6/27

125 1,531,886$

130 1,088,487$

135 645,088$

140 201,689$

2,862,082$

9.0% 3,668,864$

9.5% 3,527,696$

10.0% 3,389,302$

10.5% 3,253,611$

11.0% 3,120,554$

11.5% 2,990,066$

12.0% 2,862,082$

12.5% 2,736,539$

13.0% 2,613,378$

13.5% 2,492,539$

14.0% 2,373,965$

14.5% 2,257,602$

15.0% 2,143,395$

15.5% 2,031,293$

16.0% 1,921,245$

16.5% 1,813,202$

17.0% 1,707,117$

$-

$1,000,000

$2,000,000

80

85

90

95

100

105

Pr

$-

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

$3,500,000

$4,000,000

9.0% 9.5% 10.0% 10.5% 11.0% 11.5% 12.0% 1

NPV as func


7/27

35,0

00

40,0

00

45,0

00

50,0

00

55,0

00

60,0

00

65,0

00

70,0

00

75,0

00

Units sold

tion of sales

230

240

250

260

270

280

holesale Price

f wholesale price

f production cost


8/27

110

115

120

125

130

135

140

oduction cost

.5% 13.0%13.5% 14.0% 14.5%15.0% 15.5% 16.0%16.5% 17.0%

roduction cost

tion of WACC


9/27

tax rate 40%

WACC 10%

the market value of old machine 70,000$

Item Formula Year

1. Sell old machine

depreciation =130,000/13 = 10,000

book value today =130,000 - (130,000/13)*3 = 100,000

the market value =70,000

tax paid =0.4*(70000-100000)=-12000

net proceedings from selling the old machine =70,000 + 12000

2. Incremental Earnings

New machine

Old machine

Increase in depreciation =(150000-5000)/10 - 10000 = 4500

Cost of three engineers

Incremental EBIT

tax, 40%


3. Incremental cash flow

Change in Net Working CapitalAdd back increase in Depreciation

Purchase Equipment

Salvage value =5000



NPV


10/27

0 1 2 3 4 5 6 7 8

82,000$

40,000$ 40,000$ 40,000$ 40,000$ 40,000$ 40,000$ 40,000$ 40,000$

(25,000)$ (25,000)$ (25,000)$ (25,000)$ (25,000)$ (25,000)$ (25,000)$ (25,000)$

(4,500)$ (4,500)$ (4,500)$ (4,500)$ (4,500)$ (4,500)$ (4,500)$ (4,500)$

-$ -$ -$ -$ -$ -$ -$ -$

10,500$ 10,500$ 10,500$ 10,500$ 10,500$ 10,500$ 10,500$ 10,500$

(4,200)$ (4,200)$ (4,200)$ (4,200)$ (4,200)$ (4,200)$ (4,200)$ (4,200)$

6,300$ 6,300$ 6,300$ 6,300$ 6,300$ 6,300$ 6,300$ 6,300$

5,000$ -$ -$ -$ -$ -$ -$ (5,000)$ -$4,500$ 4,500$ 4,500$ 4,500$ 4,500$ 4,500$ 4,500$ 4,500$

(150,000)$

(63,000)$ 10,800$ 10,800$ 10,800$ 10,800$ 10,800$ 10,800$ 5,800$ 10,800$

(63,000)$ 9,818$ 8,926$ 8,114$ 7,377$ 6,706$ 6,096$ 2,976$ 5,038$

2,723$


11/27

9 10

40,000$ 40,000$

(25,000)$ (25,000)$

(4,500)$ (4,500)$

-$ -$

10,500$ 10,500$

(4,200)$ (4,200)$

6,300$ 6,300$

-$ -$4,500$ 4,500$

5,000$

10,800$ 15,800$

4,580$ 6,092$


12/27

Sales forecast (units per year) 50,000

Product life (years) 4

Expected wholesale price ($ unit) 260

Production cost ($ unit) 110

Selling, General and Administrative Costs ($ per year) 2,800,000

New equipment cost ($) 7,500,000Years of depreciation 5

tax rate 40%

Receivables (% of sales) 15%

Payables (% of COGS) 15%

WACC 12%

Item Formula Year

Incremental Revenue =50000*260

Production Costs =-50000*110

Selling, General and Administrative Costs

Depreciation =-7500000/5

Incremental Cost

Incremental EBIT

Tax, 40% =EBIT*40%


Receivables =15%*Sales

Payables =15%*COGS

Net Working Capital

Change in Net Working Capital

Add back Depreciation

Selling the equipment =7500000-7500000/5*1


WACC = 12%


NPV


13/27

0 1 2 3 4

(13,000,000)$ (13,000,000)$ (13,000,000)$

5,500,000$ 5,500,000$ 5,500,000$

2,800,000$ 2,800,000$ 2,800,000$

1,500,000$ 1,500,000$ 1,500,000$ 1,500,000$

9,800,000$ 9,800,000$ 9,800,000$ 1,500,000$

(3,200,000)$ (3,200,000)$ (3,200,000)$ 1,500,000$

1,280,000$ 1,280,000$ 1,280,000$ (600,000)$

(1,920,000)$ (1,920,000)$ (1,920,000)$ 900,000$

(1,950,000)$ (1,950,000)$ (1,950,000)$ -$

825,000$ 825,000$ 825,000$ -$

(1,125,000)$ (1,125,000)$ (1,125,000)$ -$

1,125,000$ -$ -$ (1,125,000)$

(1,500,000)$ (1,500,000)$ (1,500,000)$ (1,500,000)$

6,000,000$

6,000,000$ (2,295,000)$ (3,420,000)$ (3,420,000)$ (1,725,000)$

6,000,000$ (2,049,107)$ (2,726,403)$ (2,434,288)$ (1,096,269)$

(2,306,067)$


14/27

Units 50,000.00

Whole sale price 260.00

Cost per unit 110.00

Capital expenditures (7,500,000.00)

Years - 1 2

Revenue 13,000,000.00 13,000,000.00

COGS (5,500,000.00) (5,500,000.00)

SG&A (2,800,000.00) (2,800,000.00)

(1,500,000.00) (1,500,000.00)

EBIT 3,200,000.00 3,200,000.00

Tax rate (40%) 40% (1,280,000.00) (1,280,000.00)

Incremental Earnings 1,920,000.00 1,920,000.00

Recievables (15%) 1,950,000.00 1,950,000.00

Payables (15%) (825,000.00) (825,000.00)

Net working capital 0 1,125,000.00 1,125,000.00

EBIT(1-T) 1,920,000.00 1,920,000.00

Depreciation 1,500,000.00 1,500,000.00

+Change in Net working Capital (1,125,000.00) -

2,295,000.00 3,420,000.00

WACC 12%

(7,500,000.00) 2,049,107.14 2,726,403.06

NPV 2,862,081.81

1.) Tax rate lowering makes NPV higher

2.) Product life infinite makes NPV higher since you're creating value every 5 years

3.) Would lower NPV due to losing value and losing out on debt

4.) CHECK, does opportunity cost play a part, sunk costs too? Interesting


15/27

3 4 5

13,000,000.00 13,000,000.00

(5,500,000.00) (5,500,000.00)

(2,800,000.00) (2,800,000.00)

(1,500,000.00) (1,500,000.00) (1,500,000.00)

3,200,000.00 3,200,000.00 (1,500,000.00)

(1,280,000.00) (1,280,000.00) 600,000.00

1,920,000.00 1,920,000.00 (900,000.00)

1,950,000.00 1,950,000.00 -

(825,000.00) (825,000.00) -

1,125,000.00 1,125,000.00 - 0

1,920,000.00 1,920,000.00 (900,000.00)

1,500,000.00 1,500,000.00 1,500,000.00

- - 1,125,000.00

3,420,000.00 3,420,000.00 1,725,000.00

2,434,288.45 2,173,471.83 978,811.33


16/27

Units 50,000.00

Price 260.00

Cost 110.00

0 1 2 3

Facility (7,500,000.00)Sales 13,000,000.00 13,000,000.00 13,000,000.00

COGS (5,500,000.00) (5,500,000.00) (5,500,000.00)

SG&A (2,800,000.00) (2,800,000.00) (2,800,000.00)

Depreciation (1,500,000.00) (1,500,000.00) (1,500,000.00)

EBIT 3,200,000.00 3,200,000.00 3,200,000.00

Taxes - 40% (1,280,000.00) (1,280,000.00) (1,280,000.00)

Earnings 1,920,000.00 1,920,000.00 1,920,000.00

Receivables 1,950,000.00 1,950,000.00 1,950,000.00

Payables (825,000.00) (825,000.00) (825,000.00)

NWC 1,125,000.00 1,125,000.00 1,125,000.00

Change in NWC (1,125,000.00) 0.00 0.00

EBIT(1-T) 1,920,000.00 1,920,000.00 1,920,000.00

Change in NWC (1,125,000.00) 0.00 0.00

Depreciation 1,500,000.00 1,500,000.00 1,500,000.00

FCF 2,295,000.00 3,420,000.00 3,420,000.00

WACC - 12% 12%

(7,500,000.00) 2,049,107.14 2,726,403.06 2,434,288.45

NPV 2,862,081.81


17/27

4 5

13,000,000.00

(5,500,000.00)

(2,800,000.00)

(1,500,000.00) (1,500,000.00)

3,200,000.00 (1,500,000.00)

(1,280,000.00) 600,000.00

1,920,000.00 (900,000.00)

1,950,000.00 0.00

(825,000.00) 0.00

1,125,000.00 0.00

0.00 1,125,000.00

1,920,000.00 (900,000.00)

0.00 1,125,000.00

1,500,000.00 1,500,000.00

3,420,000.00 1,725,000.00

2,173,471.83 978,811.33


18/27

machine (130,000.00) new machine 150,000.00

mkt value 70,000.00 new depr 14,500.00

deprc (10,000.00)

3yrs (100,000.00)

Tax benefit 12000

0 1 2 3

New machine (150,000.00)

Sell machine 82,000.00

New GM 40,000.00 40,000.00 40,000.00

Old GM (25,000.00) (25,000.00) (25,000.00)

Engr costs - - -

Depreciation increase (4,500.00) (4,500.00) (4,500.00)

EBIT 10,500.00 10,500.00 10,500.00

Tax - 40% (4,200.00) (4,200.00) (4,200.00)

Earnings 6,300.00 6,300.00 6,300.00

NWC 5,000.00 5,000.00 5,000.00 5,000.00

Change in NWC 5,000.00 - - -

EBIT(1-T) 6,300.00 6,300.00 6,300.00

Change in NWC - - -

Deprc 4,500.00 4,500.00 4,500.00

Salvage value

FCF (63,000.00) 10,800.00 10,800.00 10,800.00

WACC -10% (63,000.00) 9,818.18 8,925.62 8,114.2010%

NPV 2,723.25


19/27

4 5 6 7 8 9 10

40,000.00 40,000.00 40,000.00 40,000.00 40,000.00 40,000.00 40,000.00

(25,000.00) (25,000.00) (25,000.00) (25,000.00) (25,000.00) (25,000.00) (25,000.00)

- - - - - - -

(4,500.00) (4,500.00) (4,500.00) (4,500.00) (4,500.00) (4,500.00) (4,500.00)

10,500.00 10,500.00 10,500.00 10,500.00 10,500.00 10,500.00 10,500.00

(4,200.00) (4,200.00) (4,200.00) (4,200.00) (4,200.00) (4,200.00) (4,200.00)

6,300.00 6,300.00 6,300.00 6,300.00 6,300.00 6,300.00 6,300.00

5,000.00 5,000.00 5,000.00 - - - -

- - - (5,000.00) - - -

6,300.00 6,300.00 6,300.00 6,300.00 6,300.00 6,300.00 6,300.00

- - - (5,000.00) - - -

4,500.00 4,500.00 4,500.00 4,500.00 4,500.00 4,500.00 4,500.00

5,000.00

10,800.00 10,800.00 10,800.00 5,800.00 10,800.00 10,800.00 15,800.00

7,376.55 6,705.95 6,096.32 2,976.32 5,038.28 4,580.25 6,091.58


20/27

0 1 2 3

Facility 6,000,000.00

Sales (13,000,000.00) (13,000,000.00) (13,000,000.00)

COGS 5,500,000.00 5,500,000.00 5,500,000.00

SG&A 2,800,000.00 2,800,000.00 2,800,000.00

Depreciation 1,500,000.00 1,500,000.00 1,500,000.00EBIT (3,200,000.00) (3,200,000.00) (3,200,000.00)

Taxes - 40% 1,280,000.00 1,280,000.00 1,280,000.00

Earnings (1,920,000.00) (1,920,000.00) (1,920,000.00)

Receivables (1,950,000.00) (1,950,000.00) (1,950,000.00)

Payables 825,000.00 825,000.00 825,000.00

NWC 1,125,000.00 1,125,000.00 1,125,000.00

Change in NWC 1,125,000.00 0.00 0.00

EBIT(1-T) (1,920,000.00) (1,920,000.00) (1,920,000.00)

Change in NWC 1,125,000.00 0.00 0.00

Depreciation (1,500,000.00) (1,500,000.00) (1,500,000.00)

FCF (2,295,000.00) (3,420,000.00) (3,420,000.00)

WACC - 12% 12%

6,000,000.00 (2,049,107.14) (2,726,403.06) (2,434,288.45)

NPV (2,306,067.34)


21/27

4

1,500,000.001,500,000.00

(600,000.00)

900,000.00

(1,950,000.00)

825,000.00

(1,125,000.00)

900,000.00

(1,125,000.00)

(1,500,000.00)

(1,725,000.00)

(1,096,268.69)


22/27

investment 10,000,000.00

annual cf 1,300,000.00

market risk 7.00%

risk-free 2.00%

corp tax 35.00%

beta 1.70

Equity cost 13.90000%

Equity only use the cost of equity 13.90000%

1

NPV (10,000,000.00) 1,300,000.00

9,352,517.99

(647,482.01)

Use same wacc - underlying riskiness of business remains same

No - company should use Bu and Wacc that corresponds to risk of project

cost of debt 2.0%

split 50%

Beta(L) 2.805

cost of equity 21.63500%

WACC 11.46750%

1.00

FCF (10,000,000.00) 1,300,000.00

NPV (10,000,000.00) 11336385.44

1,336,385.44


23/27

2008 2009 2010 2011

10% 9.00%

sales 19,200,000,000.00 21,120,000,000.00 23,020,800,000.00

EBIT 2,112,000,000.00 2,302,080,000.00

Capex/Deprc - -

Tax 24% (506,880,000.00) (552,499,200.00)Earnings 1,605,120,000.00 1,749,580,800.00

Change in NWC (192,000,000.00) (190,080,000.00)

EBIT(1-T) 1,605,120,000.00 1,749,580,800.00

Change in NWC (192,000,000.00) (190,080,000.00)

FCF 1,413,120,000.00 1,559,500,800.00

WACC - 10% 1,284,654,545.45 1,288,843,636.36

Enterprise 32,542,444,954.48

Cash 2,300,000,000.00

Debt (32,000,000.00)

Equity value 34,810,444,954.48

Shares outstanding 486,000,000

Price 71.63$


24/27

2012 2013 2014 2015 TV

8.00% 7.00% 6.00% 5.00%

24,862,464,000.00 26,602,836,480.00 28,199,006,668.80 29,608,957,002.24

2,486,246,400.00 2,660,283,648.00 2,819,900,666.88 2,960,895,700.22

- - - -

(596,699,136.00) (638,468,075.52) (676,776,160.05) (710,614,968.05)1,889,547,264.00 2,021,815,572.48 2,143,124,506.83 2,250,280,732.17

(184,166,400.00) (174,037,248.00) (159,617,018.88) (140,995,033.34)

1,889,547,264.00 2,021,815,572.48 2,143,124,506.83 2,250,280,732.17

(184,166,400.00) (174,037,248.00) (159,617,018.88) (140,995,033.34)

1,705,380,864.00 1,847,778,324.48 1,983,507,487.95 2,109,285,698.83 44,294,999,675.35

1,281,277,884.30 1,262,057,458.15 1,231,602,093.71 26,194,009,336.50


25/27

WACC

Beta 0.5

YTM Debt 6%

Debt 18%

Equity 82%

Risk-free 3%

Market-risk P 5%Tax rate 30%

Equity return 5.500%

WACC 5.26600%

New beta 0.61

New cost of equit 6.05%

WACC 5.71600%

Capital Budgeting

0 1 2 3 4

New Sales 3 3.50 3.00 2.50 2.00

Old Sales (2.50) (2.00) (1.50) (1.00)

Incr in cost (0.75) (0.70) (0.65) (0.40)

Kitchens (0.15)

Depreciation (0.05) (0.05) (0.05)

EBIT 0.20 0.25 0.30 0.60

Tax rate - 30% (0.06) (0.08) (0.09) (0.18)

Earnings 0.14 0.18 0.21 0.42

NWC 0.30 0.35 0.30 0.25 0.20

Change in NWC (0.30) (0.05) 0.05 0.05 0.05

EBIT(1-T) 0.14 0.18 0.21 0.42

Deprc 0.05 0.05 0.05

Change in NWC (0.05) - - 0.05

FCF 0.14 0.23 0.26 0.47

WACC 10% 0.13 0.19 0.20 0.32

(0.45) 0.13 0.19 0.20 0.32NPV 0.06

Valuation

0 1

5%

Sales 24,000,000,000.00 25,200,000,000.00

EBIT 2,400,000,000.00

Tax rate - 24 (576,000,000.00)


26/27

EBIT(1-T) 1,824,000,000.00

Change in NWC (120,000,000.00)

CapEx/Deprc -

FCF 1,704,000,000.00

Enterprise Value 34,080,000,000.00

Cash 3,300,000,000.00Debt (364,000,000.00)

Mkt value 37,016,000,000.00

Shares 453,000,000

Price 81.71$


27/27

5

1.00

(1.00)

(0.40)

(0.40)

0.12

(0.28)

0.10

0.10

(0.28)

-

(0.28)

(0.17)

(0.17)

fin 321 midterm review problems - capital budgeting, dcf valuation

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