Crawler is considering a new project that requires an investment of $90 million
ID: 2654372 • Letter: C
Question
Crawler is considering a new project that requires an investment of $90 million in machinery. This is expected to produce sales of $114 million per year for 4 years. Operating expenses are 70% of sales. Operating expenses do not include depreciation. The machinery will be fully depreciated to a zero book value over 4 years using straight-line depreciation. The salvage value is $10 million. Working capital costs are negligible. The tax rate is 40%. The unlevered cost of capital (ru) is 11%.
a) Calculate the base-case NPV.
b) Crawler plans to use $30,000,000 in bonds. The remaining funds will come from retained earnings. The bonds have a 4-year life, a coupon rate of 6% and a yield of 6%. Use the adjusted present value (APV) to find the value of the project.
Explanation / Answer
a) Calculate the base-case NPV.
Initial Investment = 90 Million
Annual Depreciation = 90/4 = 22.5 million
Annual Cash flow = (Annual Sale - Operating Expenses)*(1-tax rate) + Annual Depreciation *tax rate
Annual Cash flow = (114-70%*114)*(1-40%) + 22.5*40%
Annual Cash flow = $ 29.52 Million
Post Tax Salvage Value = 10*(1-40%) = $ 6 million
Base-case NPV = - Initial Investment + Cash flow year 1 /(1+r) + Cash flow year 2 /(1+r)^2 + Cash flow year 3 /(1+r) ^3 + Cash flow year 4 /(1+r)^4
Base-case NPV = -90 + 29.52/1.11 + 29.52/1.11^2 + 29.52/1.11^3 + (29.52+6)/1.11^4
Base-case NPV = $ 5.53658260 Million
Base-case NPV = $ 5,536,582.60
b) Crawler plans to use $30,000,000 in bonds. The remaining funds will come from retained earnings. The bonds have a 4-year life, a coupon rate of 6% and a yield of 6%. Use the adjusted present value (APV) to find the value of the project.
Adjusted present value (APV) = Base-case NPV + PV of TAX Saving on Interest Expenses
Annual Tax Saving =30,000,000*6%*40% = 720000
Adjusted present value (APV) = 5,536,582.60 + (720000/1.06 + 720000/1.06^2 + 720000/1.06^3 + 720000/1.06^4)
Adjusted present value (APV) = $ 8,031,458.64
Adjusted present value (APV) =
Adjusted present value (APV) =