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 $17 million and costs to be $8 million. Both of these are expected to grow at a rate of 20.0% per year as the excitement for the games builds. Your firm faces a 35% tax rate, a 12.5% 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 $11 million. What is the NPV of the project? Assume that you have no significant working capital costs.

Explanation / Answer

Step1; Computation of Present value of Cash flow after tax.We have,

Total present vlaue of cash flow after taxes = (6.05 + 6.30 + 6.59 + 6.92) = $ 25.86 million

Step2; Computation of Net Present Value(NPV).We have,

   NPV = Present value of cash inflow - Cash outflow

   NPV = 25.86 - 11.00 = $ 14.86 Million

Hence, Net Present Value of project is $ 14.86 Million.

Particulars 2013 2014 2015 2016 Revenue ($ in million) 17.00 20.40 24.48 29.38 Less: Cost of Good sold ($ in million) 8.00 9.60 11.52 13.82 Gross profit 9.00 10.80 12.96 15.56 Less: Depreciation 2.75 2.75 2.75 2.75 Profit before taxes 6.25 8.05 10.21 12.81 Less:Taxes@ 35% 2.19 2.82 3.57 4.48 Profit After taxes 4.06 5.23 6.64 8.33 Add: Depreciation 2.75 2.75 2.75 2.75 Cash Flow after taxes($ in million) 6.81 7.98 9.39 11.08 Present value factor@ 12.5% 0.8889 0.7901 0.7023 0.6243 Present value of Cash flow after taxes($ in Million) 6.05 6.30 6.59 6.92

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