>individual Report Example
year’s project
. Senario Analysis
Criteria
Base Worst Best 0% Probabilities ($)
Microsoft Office User: Microsoft Office User: 10,000 Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: 3,000 / unit (initial year)
Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Analysis
Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: 3,500 included)
5% Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: 12% 12% Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: Microsoft Office User: 15% 15% 15% rate
35% 0 1 2 3 4 5 NPV 0 1 2 3 4 5 Microsoft Office User: Microsoft Office User: Deviation Initial Investment NPV – 0 Deviation Depr. 0 1 2 3 4 5 0 1 2 3 4 5 – 0 FIN325 Corporate Finance . Individual Project Assignment (30%). Investment Project & Project Analysis. One of main highlights of the course for the midterm is valuing an investment project and analyzing it. Students will be able to perform the procedure of creating a spreadsheet for a hypothetical project, evaluate it with four investment criteria, and demonstrate breakeven analysis, sensitivity analysis, and scenario analysis. This assignment is very important in that students will face this type of interview questions in hiring procedure and that students planning their own business must provide investors with the investment project spreadsheet to propose a funding. Please carefully read the instruction to get a high grade and to prepare your future. A. Instruction 1. Students will create a hypothetical but realistic project just like United Pigpen (Excel Exercise) case and submit Investment proposal in Word file and Spreadsheet in Excel file. 2. Word file MUST include: (1) Project description (2) List of Input variable assumptions (3) Investment proposal (Please use the Word format below.) 3. Excel file MUST include: (1) Input variable assumptions in each cell using Note (2) FCFs spreadsheet model (3) Investment criteria (4) Breakeven analysis (5) Sensitivity analysis (6) Scenario analysis. a. You may use Spreadsheet from Excel Exercise example, which is a basic format, but students should develop their own spreadsheet model beyond the example in order to get a higher grade. b. Any other project spreadsheet from other websites or Google is acceptable but MUST include all the required work mentioned above.
B. Grading Criteria
1. Must submit Both Word file and Excel file. 2. Sharing Excel model, project description, or list of the assumptions with others will result in Zero grade both giver and receiver. (Turnitin over 50%). This is an alternative of Midterm Exam. 3. Reduction criteria. (Refer to the rubrics for the specific point reduction.) a. Just using the same Excel Example model without development won’t get full credit. b. Missing or Sharing the requirements on the Word file. c. Missing or Sharing the requirements on the Excel file. d. Failure of connecting Input variables all the way through spreadsheet. All the values in spreadsheet MUST be connected to input variables. Don’t put a hard number anywhere in spreadsheet except Input variables. (That’s the most serious failure of spreadsheet in the real business! Investors or your boss will try to change the variables to see how the investment criteria change.)
C. Due Date
1. April 5th, 11:59PM, on Sunday 2. Late Policy by the school rule. a. 10% additional reduction for any late assignment. b. Late assignments will be accepted up to two days past the due date. c. Following this 2-day grace period, there will be no marks given.
*Remove the instruction part above to avoid plagiarism.
—————————————————————————————————————————– FIN325 Corporate Finance. Individual Report Assignment (30%). Investment Project & Project Analysis. Name: 1. Project Description. (Strongly recommended to keep revising along with creating spreadsheet in Excel. Must be realistic based on research.) e.g. United Pigpen is considering a proposal to manufacture high-protein hog feed. The project would make use of an existing warehouse, which is currently rented out to a neighboring firm. The next year’s rental charge on the warehouse is $100,000, and thereafter, the rent is expected to grow in line with inflation at 4% a year. In addition to using the warehouse, the proposal envisages an investment in plant and equipment of $1.2 million…. 2. List of the input variable assumptions. (Why should be this amount? Must be realistic based on research. All input assumptions MUST be described here in Word and in a cell with Note on Excel Spreadsheet) e.g. United Pigpen case
Input variables
a. Investment $1.2 million: a similar size of investment from a competitor or industry (assumptions and research with the citation) b. Revenue $4.2 million: reasonable expected sales price per unit, expected number of goods sold (assumptions and research with the citation) c. Cost of Capital 12%: Industry average cost of capital (assumptions and research with the citation) .
*Please research and complete just one or two variables every day as if you’re planning your own project. You will be enjoying this assignment. (You have plenty of time to complete until the due date, but clock is ticking. Work on just about an hour every day and start right now to avoid procrastinating and cramming.)
3. Investment Proposal. (Why investors or your company should invest) e.g. Blooper Industry case Conclusion with key points. Results of DDP (how the project shortens the payback) NPV (how much value expected) IRR (how much profitable than cost of capital) PI (how much profitable than initial investment) Break Even Analysis (how many units to sell) Sensitivity Analysis (which variable is most sensitive) Scenario Analysis (considering risks) And other comments to propose the investment. > interaction
, , PI, PP, DPP
2 C
IRR 0
00
%
3
%
50 -350 3.83
-350 23.83 0 1 2 3 WACC NPV IRR Profitability Index Payback Period Discounted payback period 25 7% %
57.94 %
, and given the data listed below, when should you purchase the computer?
70 70 70 70 70 5
enefit at purchase
25 37 20 7
3 ” method.
Cost of Capital costs
-4 -4 -4 )
-6 )
Machine X rate nper pmt (EAC) pv fv Cost of Capital -15 5.2 Project B pv fv 0 0 per year to operate.
but is much more efficient (only $8,000 per year in operating costs)
Cost of Capital ($,thousand)
-8 -8 -8 -8 )
($,thousand)
-12 )
t
Not 0 -13.93 -13.93 -13.93 -13.93 -12 -12 Project A Project B -$200 11% PV or No
Yes , but it will increase the firm’s cash flows by a year for each of the next 8 years.
$4,000 8 9% 0 1 2 3 4 5 6 7 8 -$20,000 $4,000 $4,000 $4,000 $4,000 $4,000 $4,000 $4,000 $4,000 Solution and Explanation: NPV Yes No to install, will generate a perpetual growing stream of cash flows. Cash flow at the end of the first year will be , and cash flows in future years are expected to grow indefinitely at an annual rate of . The discount rate for this project is 10%
Input variables: 5000 5000 5000 5000 5000 5000 $5,000 5% Input variables: 21,000 33,000 Discount rate 10% Solution and Explanation: Project A Project B Input variables: 1,000 1,000 3,000 – 0 1,000 2,000 3,000 3 Solution and Explanation: Year: 0 1 2 3 4 (5,000) 1,000 1,000 3,000 – 0 (5,000) – 0 – 0 Project Payback period Year: 0 1 2 3 4 CFs (5,000) 1,000 1,000 3,000 – 0 – 0 (5,000) (1,011) CFs (1,000) – 0 1,000 2,000 3,000 CFs (5,000) 1,000 1,000 3,000 5,000 Project A, B, C False
2
Case. Blooper Industry
5
1
0
1. Inputs
Base
Worst
Best
6. Project Valuation &
Investment
Final
Probabilities
50%
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation 20%
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation
3
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation
Initial Investment
10,000
a similar size of investment from a competitor or industry (with the citation on research and assumptions)
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation 10,500
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation 9,500
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation Disc. Payback Period
useful life of the invested assets (years)
5
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation
assumptions and research with the citation
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation 5 5 5 Net Present Value
Salvage value of the fixed asset ($)
2,000
assumptions and research with the citation
assumptions and research with the citation 2,000 2,000 2,000 IRR
Sales of the fixed assets, t=5 ($)
3,000
assumptions and research with the citation
2,500
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation
3,500
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation PI
Selling price
15
reasonable expected sales price per unit, expected number of goods sold (with the citation on research and assumptions)
assumptions and research with the citation 15 1
4
assumptions and research with the citation
16
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation
Number of units sold a year
1,000
assumptions and research with the citation
assumptions and research with the citation
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation 1,000 900
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation 1,100
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation
Variable Cost (% of sales)
40%
assumptions and research with the citation
assumptions and research with the citation
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation 40% 4
5%
assumptions and research with the citation
35%
assumptions and research with the citation
7. BEP
NPV
Initial fixed Cost ($)
4,000
assumptions and research with the citation
assumptions and research with the citation
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation 4,000 4,500
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation Number of Units sold a year
Growth rate (
Inflation
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation 5% 5% 5% Selling price
Inflation
3%
assumptions and research with the citation
assumptions and research with the citation 3% 3% 3% Variable Cost (%)
Discount rate (WACC)
12%
Industry average cost of capital (with the citation on research and assumptions)
13%
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation
Accounts Receivable, as fraction of sales
17%
assumptions and research with the citation
assumptions and research with the citation 17% 17% 17%
Inventory as fraction of following years’ expenses
15%
assumptions and research with the citation
8. Restricted 4 years DPP Analysis
Tax
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation 35% 35% 35% Discount rate (WACC)
Growth Rate
2. Capital Expenditure
Fixed Cost
Investment
Sales of fixed asset
Tax on gain of sale
9. Sensitivity Analysis
Cash flows in Capital Expenditure
Selling Price
3. Operating cash flows
Deviation
assumptions and research with the citation
– 0
Revenue
VC
FC
Depr.
EBIT
Tax
Deviation
Microsoft Office User: Microsoft Office User:
assumptions and research with the citation
Cash flows in Opr.
4.
NOWC
NOWC
Cash flows of Changes in NOWC
5.
Free Cash Flows
Free Cash Flows
PV of FCFs
Cumulative PV of FCFs
.
.
2
Project
Project Interactions.
N
PV
IRR
Q. You have two proposals to choose between. The initial proposal has a cash flow that is different than the revised proposal. Using IRR, which do you prefer
?
Initial
Projects
0
1
3
W
A
C
NPV
Profitability Index
Payback Period
Discounted payback period
Free Cash Flows
-3
5
4
7
23.
8
14.2
9
1.07
0.88
0.94
Cumulative Payback
-350
PV of CF
37
Cumulative Disc. Payback
Revised Projects
Free Cash Flows
-375
25
475
57.94
12.5
6
1.15
2.68
2.85
Cumulative Payback -375 -350
-325
150
PV of CF -375
23.36
21.84
387.74
Cumulative Disc. Payback -375
-351.64
-329.
80
Problem 1. The investment Timing Decision
You may purchase a computer anytime within the next five years. The computer will save your company money only for the year when you purchase
and the cost of computers continues to decline. If your cost of capital is
10
Cost of Capital
10% 0 1 2 3 4 5
Savings
70
– Cost
-50
-4
-40
-36
-33
-31
=
B
20
30
34
39
PV of Benefit
22.73
24.79
25.54
2
5.2
24.22
Invsetment Timing (year)
Problem 2. The choice between long and short-lived equipment
EX 1. Choosing Lowest Annual Cost.
Given the following costs of operating two machines and a 6% cost of capital, select the lower cost machine using “
Equivalent Annual Cost
6% 0 1 2 3
NPV of Cost
Machine X
-15
(
25.69
Machine Y costs
-10
-6
(
21.00
Lower cost Machine: X or Y
Machine I
rate
nper
pmt (EAC)
pv
fv
6% 3 ? 25.69 0
($9.61)
Machine J
6% 2 ? 21.00 0
($11.45)
EX 2. Choosing Highest Annual Cash Flows of the projects.
Select one of the two following projects based on highest Value “Equivalent Annual Annuity” (r = 9%).
9% 0 1 2 3 4
NPV of Project
Project A
4.9
5.9
6.2
2.82
Project B
-20
8.1
8.7
10.4
2.78
Higher EAA project: A or B
Project A rate nper
pmt (EAA)
9% 4 ?
(2.82)
$0.87
Project B rate nper pmt (EAA) pv fv
9% 3 ?
(2.78)
$1.10
Problem 3. When to replace an old machine, calcualating PV of operating cost
Q. You are operating an old machine that will last 2 more years before it gives up the ghost. It costs $1
2,000
You can replace it now with a new machine that costs $2
5,000
and will last for 5 years. Should we replace the machine now or stick with it for a while longer? The opportunity cost of capital is 6%
6% 0 1 2 3 4 5 NPV
New
-25
-8
(
58.70
Old
-12
(
22.00
Replacement or
No
New rate nper pmt (EAC) pv fv
6% 5 ? 58.70 0
($13.93)
Old rate nper pmt (EAC) pv fv
6% 2 ? 22.00 0
($12.00)
Equivalent Annual Cost 0 1 2 3 4 5
New ($,thousand)
-13.93
Old ($,thousand)
NPV & PI
Relationship between NPV and PI
The following are the cash flows of two projects:
Is the project with the highest profitability index also the one with the highest NPV?
Input variables:
Year
0
-$200
1 80
100
2 80 100
3 80 100
4 80
Cost of capital
11%
Solution and Explanation:
Projects
Profitability index
Project A
1.2410
$248.20
Project B
1.2219
$244.37
High PI/high NPV?
Yes
Notes:
The project with the higher PI must also have the higher NPV.
IRR &
Discount rate
Relationship between IRR & Discount rate
A new computer system will require an initial outlay of
$
20,000
$4,000
Input variables:
Initial investment
–
$20,000
(input as a negative)
Annual cash flow
Years
Discount rate 1
Discount rate 2
1
4%
Year:
Cash flow:
a. Calculate the NPV and decide if the system is worth installing if the required rate of return is 9%. What if it is 14%?
Discount Rate
Installing? Y/N
9%
$2,139.28
14%
-$1,444.54
b. How high can the discount rate be before you would reject the project?
IRR
11.81%
NPV & DDM
NPV & DDM
Growth Enterprises believes its latest project, which will cost
$80,000
$5,000
5%
Initial investment
-$80,000
Input as a negative
5000
Year 1 cash flow
Cash flow growth rate
Discount rate 10%
a. If , what is the project NPV?
PV of Future Cash Flows
$100,000
NPV $20,000
b. What is the project IRR?
IRR
11.25%
Note!
IRR = r = (CF1/Initial Investment) + g
based on DDM model. PV = D1/(r-g)
NPV & IRR
NPV vs. IRR
Consider projects A and B:
Project 0 1 2
NPV @ 10%
Project A
(30,000)
2
1,000
6,446
Project B
(50,000)
3
3,000
7,273
a. Calculate IRRs for A and B.
IRR
Project A
25.69%
Project B
20.69%
b. Which project does the IRR rule suggest is best?
Project A or B
IRR selection
c. Which project is really best?
Project A or B
Best selection
PP vs. DPP
Payback Period vs. Discounted Payback Period
Here are the expected cash flows for three projects:
the opportunity cost of capital is 10%
Projects 0 1 2 3 4
A
(5,000)
– 0
B
(1,000)
C (5,000) 1,000 1,000 3,000 5,000
Cutoff years
Discount Rate 10%
a. What is the payback period on each of the projects?
Project
Payback period
A 3
CFs
Cumulative CF
(4,000)
(3,000)
B 2 CFs (1,000) – 0 1,000 2,000 3,000
Cumulative CF (1,000) (1,000) – 0 2,000 5,000
C 3 CFs (5,000) 1,000 1,000 3,000 5,000
Cumulative CF (5,000) (4,000) (3,000) – 0 5,000
b. If you use a cutoff period of 3 years, which projects would you accept under payback period criteria?
Project A, B, C
Accept projects
A,B,C
c. What is the payback period on each of the projects?
A
longer than 4 years
PV of CF (5,000)
909
826
2,254
Cumulative PV
(4,091)
(3,264)
(1,011)
B
2.12
PV of CF (1,000) – 0 826
1,503
2,049
Cumulative PV (1,000) (1,000)
(174)
1,329
3,378
C
3.30
PV of CF (5,000) 909 826 2,254
3,415
Cumulative PV (5,000) (4,091) (3,264) (1,011)
2,405
d. If you use a cutoff period of 3 years, which projects would you accept under discounted payback period criteria?
Accept projects B
e. “Payback gives too much weight to cash flows that occur after the cutoff date” True or
False
True/False
EAC
vs.
| Equivalent Annual Cost. | ||||
| A firm can lease a truck for 4 years at a cost of | $30,000 | |||
| with annual maintenance expenses of | $10,000 | |||
| What is the equivalent annual cost of buying and maintaining the truck if the discount rate is 10%? | ||||
| Lease/Truck life in years | ||||
| Lease annual cost | ||||
| Cost to buy truck | ||||
| Truck annual cost | ||||
| Truck sale ending sale price | ||||
| PV of costs of BUY | (91,208.3) | |||
| Equivalent annual cost of BUY | (28,773.5) | |||
| Lease or buy | ||||
| Lease or Buy | ||||
| (95,096) | ||||
| (80,000) | (10,000) | (91,208) | ||
| Buy EAC | ||||
| 91,208.25 | ||||
| ($28,773.54) |
EAC New vs. Old
| EAC: New vs. Old | |||||||||||||||||||||||
| A forklift will last for only 2 more years. It costs $5,000 a year to maintain. For $20,000 you can buy a new lift that can last for 10 years and should require maintenance costs of only | $2,000 | ||||||||||||||||||||||
| Old lift life in years | |||||||||||||||||||||||
| Annual maintenance old lift | |||||||||||||||||||||||
| Cost new lift | |||||||||||||||||||||||
| New lift life in years | |||||||||||||||||||||||
| Annual maintenance new lift | |||||||||||||||||||||||
| a. Discount rate | |||||||||||||||||||||||
| b. Discount rate | 12% | ||||||||||||||||||||||
| a. Calculate the equivalent cost of owning and operating the forklife if the discount rate is 4% per year. | |||||||||||||||||||||||
| (20,000) | (2,000) | ( | 36,222 | ||||||||||||||||||||
| (9,430) | |||||||||||||||||||||||
| Equivalent annual cost of the new | (4,465.82) | ||||||||||||||||||||||
| Replace? | |||||||||||||||||||||||
| b. Calculate the equivalent cost of owning and operating the forklife if the discount rate is 12% per year. | |||||||||||||||||||||||
| ( | 31,300 | ||||||||||||||||||||||
| (8,450) | |||||||||||||||||||||||
| (5,539.68) | |||||||||||||||||||||||
| Relace? |
>Blooper Industry
year’s project
. Inputs
. Project Valuation & Criteria
,000
.26
5 .65
%
,000
(% of sales)
($)
rate
0 1 2 3 4 5 ,000
– 0 – 0 – 0 – 0 – 0 – 0 – 0 – 0 – 0 (3000- 0)*35%
– 0 – 0 – 0 – 0 0 1 2 3 4 5 s
– 0 0*(1+3% inflation)
(Straight Line)
– 0 1,600 1,600 1,600 1,600 00-2000)/5
– 0 – 0 1,600 1,600 1,600 1,600 1,600 0 1 2 3 4 5 – 0 4,721 – 0 0 1 2 3 4 5 (11,500) (11,500) )
a year. In addition to using the warehouse, the proposal envisages an investment in plant and equipment of $1.2 million. This could be depreciated for tax purposes straight-line over 10 years. However, Pigpen expects to terminate the project at the end of 8 years and to resell the plant and equipment in year 8 for $400,000. Finally, the project requires an immediate investment in working capital of $350,000. Thereafter, working capital is forecasted to be of sales in each of years 1 through 7. Working capital will be run down to zero in year 8 when the project shuts down. Year 1 sales of hog feed are expected to be $4.2 million, and thereafter, sales are forecasted to grow by 5% a year, slightly faster than the inflation rate. s are expected to be of sales, and profits are subject to tax at 35%. The cost of capital is 12%. What is the NPV, IRR, DPP, PI of Pigpen’s project?
6. Project Valuation & Investment Criteria Disc. Payback Period Net Present Value 5% IRR 90% PI 100 4% 10 35% 400 350 10% 12% of fixed assets
– 0 – 0 – 0 – 0 – 0 – 0 – 0 – 0 – 0 – 0 – 0 – 0 – 0 – 0 – 0 0 1 2 3 4 5 6 7 8 – 0 4,200 2
9
– 0 100 76 82 96 – 0 563 251 273 86 3 5 35% 40,000 18,000 Dividend Model.
per share, and it is widely expected that the dividend will increase by per year indefinitely.
?
.
5.00
%. What must be the expected growth rate of the company’s dividends?
-5/50
per year with the following financial data.
15% $3 -10.00% 15% 15% 15% 10% at year 1
.00
$1.00 $66.67 =8/12% 12% 0% 12% – 0%
per share this year. Its is . What is the stock price?
$2.40 18 & P/E, million by selling shares of stock. Management plans to earn a %
rate of return on equity, which is more than the 15% rate of return available on comparable-risk investments. of all earnings will be reinvested in the firm.
200 Book value ($, million) 200 =200 24% Return on equity (%) 12% =12% Earnings ($, million) 24 40% Plowback(Retention) ratio (%) 40% =40% Dividends ($, million) 14 10% g (%) 5% 15% =15% Discount rate (%) 15% =15% Market value ($, million) P/E ratio P/B ratio per year, and you expect this growth rate in earnings and
Data. 20% $2 4% DIV1 2.40 =D15*(1+C9) = $1 per share.
Input variables: 20% 4 5% 10% ?
10.00% of all earnings into the firm. Earnings this year will be $3 per share, and investors expect a 12% rate of return on stocks facing the same risks as Web Cites.
Input variables: 70%
2
Case. Blooper Industry
5
1
6
Investment
Initial Investment ($)
1
0
Disc. Payback Period
4
useful life of the invested assets (years)
Net Present Value
5,09
8
Salvage value of the fixed asset ($)
2,000
IRR
24.0
7
Sales of the fixed assets, t=5 ($)
3
PI
1.44
Selling price / unit (initial year)
15
Number of units sold a year
1,000
Variable Cost
40%
Fixed Cost
4,000
Growth rate (Inflation included)
5%
Inflation on Fixed cost
3%
Discount rate (WACC)
12%
Accounts Receivable, as fraction of sales at current year
17%
Inventory as fraction of following years’ expenses
15%
*Assuming Inventory (Direct Material, Direct Labor, Work In Process) sold next year
Tax
35%
2. Captial investment
–
Investment in fixed assets
10
– 0
+
Sales of fixed assets
3,000
–
Tax of Gain on sales of fixed assets
350
=
200
=
Cash Flow in fixed assets
(10,000)
2,650
3.
Operating Cash Flows
+
Revenue
15,000
15,750
16,538
17,364
18,233
– Variable Cost – 0
6,000
6,300
6,615
6,946
7,293
– Fixed Cost – 0 4,000
4,
120
4,244
4,371
4,502
=
400
–
Depreciation
1,600
=(
100
=
Profit before tax (EBIT)
3,400
3,730
4,079
4,448
4,838
– Tax – 0
1,190
1,306
1,428
1,557
1,693
+
Add back Depreciation
= Operating Cash Flows – 0
3,810
4,025
4,
251
4,491
4,744
=17%*15000+15%*(6300+4120)
4. Change in working capital
–
Working capital
1,500
4,113
4,306
4,509
4,721
Must be zero
=
Cash Flows of Changes in net Working capital
(1,500)
(2,613)
(193)
(203)
(212)
5. Project Cash flows
Project cash flows
(11,500)
1,197
3,831
4,049
4,279
12,116
Present Value of projected cash flows
1,069
3,054
2,8
82
2,719
6,875
Cumulative PV of projected cash flows
(10,431)
(7,377)
(4,495)
(1,7
76
5,099
United Pigpen
United Pigpen Case. 8 year project
United Pigpen is considering a proposal to manufacture high-protein hog feed. The project would make use of an existing warehouse, which is currently rented out to a neighboring firm. The next year’s rental charge on the warehouse is $100,000, and thereafter, the rent is expected to grow in line with inflation at
4%
10%
Manufacturing cost
90%
1. Input variables ($,thousand)
Investment
1,200
7.83
Revenue
4,200
85.80
Rev growth (%)
13.19%
Manufacture costs (% of sales)
1.06
Rent (opp. Cost)
Rent Growth (%)
Dep’n Life (years)
Tax Rate (%)
Plant Sale, t=8
WC investment, t=0
WC ongoing, t1-7, % of sales
Cost of Capital (%)
2. Captial investment 0 1 2 3 4 5 6 7 8
– Investment in fixed assets 1,200 – 0 – 0 – 0 – 0 – 0 – 0 – 0 – 0
+ Sales of fixed assets 400
–
Tax of
Gain on Sale
56
=(400-(1200-120*8))*35%
= Cash Flow in fixed assets
(1,200)
344
3. Operating Cash Flows
+
Revenues
4,410
4,631
4,
86
5,105
5,360
5,628
5,910
– Manufacturing cost – 0
3,780
3,
96
4,167
4,376
4,595
4,824
5,066
5,319
–
Rent Opportunity cost
104
108
112
117
122
127
132
– Depreciation – 0 120 120 120 120 120 120 120 120
= Profit before tax (EBIT) – 0 200
217
235
254
274
294
316
339
– Tax – 0
70
89
103
111
119
+ Add back Depreciation – 0 120 120 120 120 120 120 120 120
= Operating Cash Flows – 0
250
261
273
285
298
311
326
341
4. Change in working capital 0 1 2 3 4 5 6 7 8
– Working capital 350
420
441
463
486
511
536
563
= Cash Flows of Changes in net Working capital
(350)
(70)
(21)
(22)
(23)
(24)
(26)
(27)
5. Project Cash flows 0 1 2 3 4 5 6 7 8
Project cash flows
(1,550)
180
240
262
286
299
1,247
Present Value of projected cash flows (1,550)
161
191
178
166
155
145
135
504
Cumulative PV of projected cash flows (1,550)
(1,389)
(1,198)
(1,020)
(853)
(698)
(553)
(418)
Gain on Sale after tax
Cash Flows. Tax from Gain on Sales of Invested Asset
Quick Computing installed its previous generation of computer chip manufacturing equipment 3 years ago. Some of that older equipment will become unnecessary when the company goes into production of its new product. The obsolete equipment, which originally cost $40 million, has been depreciated straight-line over an assumed tax life of 5 years, but it can be sold now for $18 million. The firm’s tax rate is 35%. What is the after-tax cash flow from the sale of the equipment?
Input variables:
($ thousand, %)
Age of equipment
Initial cost
40,000
Useful life
Current market value
18,000
Tax rate
Solution and Explanation:
($ thousand)
Initial Cost (Original Cost)
Accumulated Depreciation (3years)
24,000
=40000/5*3
Book Value
16,000
=40000-40000/5*3
Sales Price
Gain on Sale 2,000
=18000-16000
Tax on Gain
700
=2000*35%
Cash flow. Gain on sale after tax
17,300
=18000-700
DDM
Discount
Q1. Gentleman Gym just paid its annual dividend of
$3
5%
a. What price should the stock sell at if the discount rate is
15%
Current
Price
$31.50
=3*(1+5%)/(15%-5%)
b. What price should the stock sell at if the discount rate is
12%
Current Price
$
4
=3*(1+5%)/(12%-5%)
Q2. Arts and Crafts, Inc., will pay a dividend of $5 per share in 1 year. It sells at $50 a share, and firms in the same industry provide an expected rate of return of
14
Expected growth rate
4.0
0%
=1
4%
Yields
Yields. Income Gain and Capital Gain in DDM Model
Horse and Buggy Inc. is in a declining industry. Sales, earnings, and dividends will be all shrinking at a rate of
10%
Input data.
Annual growth rate
–
10.00%
Required return
DIV1
a. what is the value of a share today?
Value of a share
$12.00
=3/(15%+10%)
b. What price do you forecast for the stock next year?
Stock price
10.800
=3*(1-10%)/(15%+10%)
c. What rate of return should you expect if you buy the stock today and sell it in one year?
Expected rate of return
15.00%
=15%
c-1. What is the income gain and the capital gain if you buy the stock today and sell it in one year?
Income gain (Dividend Yield)
25.00%
=3/12
Capital gain (Investment Yield, g)
=-10%
Growth
Growth
Here are the forcasted data on two stocks of the year 1, both of which have discount rates of 15%:
a. What are the dividend payout ratios for each firm?
b. What are the expected dividend growth rates for each firm?
c. What is the proper stock price for each firm?
Stock A
Stock B
Discount rate
Return on equity at year 1
Earnings per share
$2
$1.50
Dividends per share at year 1
$1.00
a. Dividend payout ratio
50.00%
66.67%
=1/1.5
b. Expected dividend growth
7.50%
3.33%
=10%*(1-66.67%)
c.
Stock price today
$13.33
$8.57
= 1/(15%-3.33%)
PS valuation
Preferred Stock Valuation.
Preferred Products has issued preferred stock with an annual dividend of $8 that will be paid in perpetuity.
Input variables:
Annual dividend
$8.00
Discount rate
12.00%
a. If the discount rate is 12%, at what price should the preferred sell?
Price0
$66.67
=8/12%
b. At what price should the stock sell 1 year from now?
Price1
c. What is the dividend yield, the capital gains yield, and the expected rate of return of the stock?
Dividend yield
=8/66.67
Capital gains yield
=(66.67-66.67)/66.67
Rate of return
=12%
PE ratio
Price Earning (P/E) Ratio
Favorita Candy’s stock is expected to earn
$
2.40
P/E ratio
18
Data.
EPS
=2.4
P/E Ratio
=18
Price
$43.20
=C5*C6
Growth & Multiples
Return on Equity
P/B ratio
Start-Up Industries is a new firm that has raised $
200
24
40%
a. when ROE 24%
b. when ROE 12%
Book value ($, million)
=200
Return on equity (%)
=24%
Earnings ($, million)
48
=200*24%
=200*12%
Plowback(Retention) ratio (%)
=40%
Dividends ($, million)
29
=48*(1-40%)
=24*(1-40%)
g (%)
=24%*40%
=12%*40%
Discount rate (%)
Market value ($, million)
533
=C10/(C12-C11)
141
=F10/(F12-F11)
P/E ratio
11.11
=C13/C8
5.88
=F13/F8
P/B ratio
2.67
=C13/C6
0.71
=F13/F6
Permanent value
Stock Price with Permanent Value
Q. Tattletale News Corp. has been growing at a rate of
20%
dividends to continue for another 3 years. If the last dividend paid was $2, the discount rate is 15% and
the steady growth rate after 3 years is 4%, what should the stock price be today?
Growth rate for Years 1-3
Last dividend paid
Discount rate 15%
Growth rate after 3 years
Stock price PV0
DIV2
DIV3
28.02
2.88
3.46
=D15*(1+C9)
28.02
=C10*(1+C9)
=C15*(1+C9)
32.67
PV3
Short-cut of PV0
=(E15*(1+C12))/(C11-C12)
=C15/(1+C11)^1+D15/(1+C11)^2+(E15+E16)/(1+C11)^3
=NPV(C11,C15,D15,E15+E16)
Holding Return
Expected Holding Period Rate of Return
Better Mousetraps has come out with an improved product, and the world is beating a path to its door. As a result, the firm projects growth of 20% per year for 4 years. By then, other firms will have copycat technology, competition will drive down profit margins, and the sustainable growth rate will fall to 5%. The most recent annual dividend was
DIV0
Initial growth rate
Initial growth rate years
Sustainable growth rate
DIV0 $1.00
Discount Rate
a. What are the expected values of DIV1, DIV2, DIV3, and
DIV4
DIV1
$1.2000
=C9*(1+C6)
DIV2
$1.4400
=C13*(1+$C$6)
DIV3
$1.7280
=C14*(1+$C$6)
DIV4
$2.0736
=C15*(1+$C$6)
b. If the discount rate is 10%, what is the expected stock price 4 years from now?
Stock Price in 4 yrs (HV4)
$43.5456
=C16*(1+C8)/(C10-C8)
c. What is the stock price today?
Stock price today
$34.738
=NPV(C10,C13,C14,C15,C16+C19)
d. Find the dividend yield, DIV1 / P0.
Dividend yield year 1
3.45%
=1.2/C22
e. What will next year’s stock price, P1, be?
Expected Stock price at year 1
$37.012
=NPV(C10,C14,C15,C16+C19)
f. What is the expected rate of return to an investor who buys the stock now and sells it in 1 year?
Expected Return at year 1
=(37.012-34.738+1.2)/34.738
PVGO
Present Value of Growth Opportunities (PVGO)
Web Cites Research projects a rate of return of 20% on new projects. Management plans to pay back
70%
Return on Equity 20%
Payback ratio
Earnings per share $3
Required return 12%
a. What is the sustainable growth rate?
Sustainable growth rate
6.00%
=C6*(1-C7)
b. What is the stock price?
Stock price
$35.00
=3*70%/(12%-6%)
c. What is the P/E ratio?
P/E ratio
11.67
=C15/C8
d. What would the price and P/E ratio be if the firm paid out all earnings as dividends?
Stock price
$25.00
=C8/C9
P/E ratio
8.33
=C21/C8
e. What is the present value of growth opportunities (PVGO)?
PVGO
$10.00
=C15-C21
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