CORE IS Activity 20 Cash Flow Estimation Group Number Class meeting Morning DAft
ID: 2784426 • Letter: C
Question
CORE IS Activity 20 Cash Flow Estimation Group Number Class meeting Morning DAfternoon As the new CEO of Pemrose Corp (Carlton Whitfield), you are announcing a bold new expansion plan. This entails building a new factory. The initial cost is $500 million, it will last 8 years and is depreciated straight-line to a book value of 0. Salvage value of the factory at t = 8 is $100 million. Annual sales and costs will be $300 million and $200 million respectively (in all 8 years). Inventories will rise immediately by $15 million and A/P will rise immediately by $30 million. A/R will rise at the end of the first year by $20 million (t 1). All working capital components return to original values at the end of the project's life. WACC = 10% and -30%. What is the NPV?Explanation / Answer
We have,
Initial Cost = $ 500 million
Life= 8 years
Salvage Value = $ 100 million
Annual Sales because of this activity = $ 300 million
Annual cost because of this activity = $ 200 million
Added inventory = $ 15 million
EBITDA = $ 300-200-15 million = $ 85 million
Account Payable = $ 30 million
Account Receivable = $ 20 million
WACC = 0.1
Tax Rate = 0.3
Annual Depreciation = $ (500 / 8 ) million = $ 62.5 million
Depreciation is a accounting thing and has nothing to do with the cash flow but it will determine the net income in the year. NPV is calculated with net cash flow.
tax paid = $ (85-62.5) * (tax rate) million = $ 22.5*0.4 million = $ 9 million
Cash Flow in 0 years = - $ 500 million
Cash Flow in 1 to 7 year = $ (85 -9 + 30 - 20 ) million = $ 86 million
Cash Flow in 8th year = $ (86 + 100 ) million = $ 186 million
NPV = CF0 + CF1/(1+WACC) + CF2/(1+WACC)^2 + CF3/(1+WACC)^3 + CF4/(1+WACC)^4 + CF5/(1+WACC)^5 + CF6/(1+WACC)^6 + CF7/(1+WACC)^7 + CF8/(1+WACC)^8
= $ (-500 + 86/1.1 + 86/1.1^2 + 86/1.1^3 + 86/1.1^4 + 86/1.1^5 + 86/1.1^6 + 86/1.1^7 + 186/1.1^8) million
= $ 5,454,391.04 i.e. 5.45 million