Fresh off the excitement of the 2012 London Olympic Games, you decide that you w

Question

Fresh off the excitement of the 2012 London Olympic Games, you decide that you want your firm to take advantage of the profits to be made for the 2016 games in Rio de Jeneiro. To do so you plan to open a factory in Brazil. After examining the idea, your CFO projects revenues next year (2013) to be $15 million and costs to be $8 million. Both of these are expected to grow at a rate of 24.0% per year as the excitement for the games builds. Your firm faces a 35% tax rate, a 13.0% discount rate and you can depreciate your new investment using the straight line method over the four years leading up to the games, at which point the value of the venture moving forward will be $6 million. This $6 million is the after-tax terminal value that is in year 4 (that is, 2016) dollars and is the PV of all cash flows year 5 and beyond. The capital expenditure of this project is $12 million. What is the NPV of the project? Assume that you have no significant working capital costs.

Explanation / Answer

Answer:

Calculation Showing Net Present value of the Project:

Net Present value = Initial Investment - {[Cash Flow for year 1 / (1+r)^1] + [Cash Flow for year 2 / (1+r)^2] + [Cash Flow for year 3 / (1+r)^3] + [Cash Flow for year 4 / (1+r)^4] }

Here,

r = 13% = 0.13(13/100)

Initial Investment = $12,000,000

Cash Flow for year 1=7,000,000

Cash Flow for year 2 =8,680,000 (Increased by 24% in comparison to year 1 )

Cash Flow for year 3=10,763,200 (Increased by 24% in comparison to year 2 )

Cash Flow for year 4=19,346,368 (13,346,368 +6,000,000) (Increased by 24% in comparison to year 3 + after tax terminal value incurred in year 4 )

Therefore , using the above formula and values,

Net present value of the project = $20,317,330.79

Notes:

1. Cost is considered inclusive of depriciation.

2. Tax rate is not onsidered in the above calculations.

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