Corporate Finance - Cash Flow Estimation - Class Exercise - 71. Company X has a capital structure which is based on 30 percent debt, and 70 percent common stock. The pre-tax cost of debt is 8 percent, and the cost of common stock is 11 percent. The company's tax rate is 34 percent. The company is considering a project that is equally as risky as the overall firm. This project has initial costs of $250,000 and cash inflows of $94,000 a year for three years. What is the projected net present value of this project?

2. Company X is deciding whether to expand its production facilities. The management has projected the following cash flows for the first two years Rs in CroresYr 1Yr 2

Revenue125160

Cost of Goods Sold & Operating Expenses4060

Depreciation2536

Increase in Working Capital58

Capital Expenditure3040

Marginal Corporate Tax35%35%

a) What are the earnings for this project for years 1 and 2 assuming there is no loans?b) What are the free cash flows (FCFF) for this project for the first two years?

3. Company X is considering a project about which the estimated Capex and Opex are provided below:Rs in CroresYr 0Yr 1Yr 2Yr 3

Capital Expenditure(75)(75)00

Working Capital(20)10130

Revenue100130175

Cost of Goods Sold405270

Gross profit6078105

Operating Expenses202020

EBIDTA405885

Depreciation101010

EBIT304875

Interest888

EBT224067

Tax7.71423.45

EAT14.32643.55

(a) Based on above compute the FCF for the project (b) If the opportunity cost of the project is 15% should company X accept the project?

4. Company X is considering a capital project about which the following information is available: Investment outlay on the project will be Rs. 10 crores which includes Rs. 2 crores of working capital Project life is expected to be 5 years. At the end of the 5 years the fixed assets will fetch a salvage value of Rs. 3 crores whereas the working capital will be released Project is expected to increase the revenue of the firm by Rs. 12 crore every year. The increase in cost on account of project is expected to be Rs. 8 crore per year. Effective tax rate will be 30%. Plant and machinery will be depreciated at the rate of 25% per year on written down value methodCompute the Free Cash Flow of the project for five years. If the opportunity cost of the project is 15% should the company undertake the project?

Compute the above using the net salvage value in accordance with the Indian tax laws.

5. Company X is determining the cash flow for a project involving replacement of an old machine by a new machine. The old machine bought a few years ago has a book value of Rs. 4.0 lakhs and it can be sold to realize a post tax salvage value of Rs 5.0 lakhs. It has a remaining life of five years after which its net salvage value is expected to be Rs. 1.6 lakhs. The company is following a depreciation rate of 25% under the written down value method. The working capital required for the old machine is Rs. 4.00 lakhs.

The new machine costs Rs. 16.0 lakhs. It is expected to fetch a net salvage value of Rs. 8.0 lakhs after 5 years when it will be no longer required. The depreciation rate is to be considered same as that of existing machine. The net working capital required for the new machine is Rs. 5.00 lakhs. The new machine is expected to bring a saving of Rs. 3.0 lakhs annually in manufacturing costs (other than depreciation). The tax rate applicable to the firm is 40%.

If the weighted average cost of capital is 15% then should the company procure the new machine? (Incremental Principle)

6. Ram Singh has received an inheritance of Rs. 3 lakhs from his father. He is currently working in materials management in a company, and his salary is Rs. 36,000 per year. He is considering two alternative investments of his inheritance:Option 1: Deposit Rs. 3.0 lakh in a 13 year Term deposit at 15% interest p.a and continue with the job.Option 2: Purchase and operate a general store and leave the job He has to spend Rs. 2.4 lakhs towards building and fixtures including Rs. 1.0 lakh towrds merchandise. He also has to invest Rs. 0.60 lakhs towwards working capital Annual income expected - Rs. 3.9 lakhs per anum Annual Expenses estimated - Rs. 3.0 lakhs per anum At the end of 13 years he wish to retire and hence has estimated the net salvage value of the store at Rs. 50,000 Personal Income tax - 30%Which course of action would Ram Singh chose? Assume straight line method for depreciation with life of asset as 13 years. Assume no growth in the salary or the income from business of Ram Singh.7. Company X is considering a project with an estimated cash flows as provided in the Table below. Yr 0Yr 1Yr 2Yr 3Yr 4Yr 5

-10,00035003500350035003500

The opportunity cost of capital for the company was 15% (Nominal). Based on the above would you recommend to accept the project.

It was realized later that while estimating the cash flows the inflation during the period has not been considered which is expected to be 6%. Will your decision change if you take inflation into consideration? (Consistency principle)

8. Use MS Excel the solve the following question:

Company X is considering a new machine which cost is estimated as Rs. 2.5 crores. The annual capacity of the plant is 50,000 packets with market price set at Rs. 140/packet. The variable cost per packet will be Rs. 85/packet.

The initial fixed cost would be Rs. 150 lakh which includes one time promotion expenditure of Rs. 75 lakh in the first year. Written down depreciation for tax purposes is 25%. Working capital requirement in the beginning of the year is estimated to be 15% of the sales. The company expects its revenue and costs to be affected by inflation which is expected to be 4.6% per anum. The company expects that the plant capacity utilization over its economic life of 5 years will be as follows:

Year12345

Capacity Utilization (%)25355075100

The terminal value of the project is estimated to be Rs. 25 lakh. Calculate the project's NPV assuming a rate of return of 9%. The corporate tax rate is 35%. Assume that the depreciation is charged on the block of assets as per the current tax laws in India.