Problem: Calculate on the difference between FCF Do – FCF Don’t Do Prepare a tem
ID: 2658274 • Letter: P
Question
Problem: Calculate on the difference between FCF Do – FCF Don’t Do
Prepare a template of doing the project and then a second template of not doing the project
Assumptions change
If you don’t do the project you will sell the land in Y0
Compare the two and calculate incremental NPV
Sunk costs
Ignore, not incremental
$50 spent two years ago, we are not getting back
Given Information:
2 year project
Capital required for P&E = $2500 in Y0
WC = $550 in Y1 and $600 in Y2. Total not incremental WC & required at beginning of the year
Salvage value of P&E at end of 2 years = $900
Depreciation in each of first 2 years = $1,000
Production is 1,000 units per year.
Assume revenue & costs are all incurred at the end of each year
Price = $2 / unit in Y1 and increases at a rate of 20%
Operating costs in Y1 = $400, Y2 = $500
Company owns land on which to build a plant which has a book value of $300. The current market value is $300 but it is expected to rise at an annual rate of 5%. The land will be sold after 2 years.
Company originally planned to start the project 2 years ago and spent $50 in planning, but shelved it.
Tax rate = 34%
Cost of capital = 15%
Tax on asset sale
Profit / loss = Sale Proceeds – Book value
Book value = Purchase price – accumulated depreciation
Suppose you bought equipment for $2,500, depreciated it for two years at $1,000 per year and sell it for $900 at the end of the second year
Purchase price = $2,500
Accumulated depreciation = $2,000
Book value = $2,500 – 2,000 = $500
Taxable profit in Y2 = $900 – 500 = $400
______________________________________
Include in template
Working Capital
Year 0,1,2
Revenue
Cash Costs
Depreciation of Equiptment
Profit/Loss from asset sale
Equiptment
Land
Taxable operating income
Tax on operating income
Net oper profit after tax
Depreciation of Equiptment
Profit/loss from asset sale
Equiptment
Land
Operating cash flow
Changes in working capital
Capital Expenditure
Cash Flow from asset sale
Equiptment
Land
Free Cash flow to all capital
Note: Working on this problem, posting on Chegg to check my answer.
Explanation / Answer
Hello
Tax on profit on sale of P&E = 900(sale) - 500(Book Value)=400(profit)*(0.34)=$136
Working Capital is total, therefore , for year 2, WC=600-550= $50
$900 salvage value is added to the cash flow.
$300 value of land is an asset and it is not a determinant for the taking up of the project as the company already owns the land and has not bought it for the purpose of the project.
The $50 spent 2 years back would have been taken into account (P&L account) because it has already been shelved.
The initial investment is $2500
PV of future cash flows from the project = $2656.41
Therefore, NPV of the project is $156.41.
The incremental cash flow in year 1 is $1033 (PV=$898.71) and in year 2 it is $2325(PV=$1757.7)
If we don't do the project then we would get $300 in year 0.
The land will be sold at $330.75 after 2 years
SUGGESTION : It is better to take up the project than selling off the land because if the project is taken there would be a benfit of $106.457(406.457-300).
I hope this clears your doubt.
Feel free to comment if you still have any doubt.
Do give a thumbs up if you find this helpful.
Year 1 2 Revenue 2000.00 2400.00 Operating costs (400.00) (500.00) Working Capital (550.00) (50.00) Depriciation (1000.00) (1000.00) Profit Before Tax 50.00 850.00 Tax(@34%) (17.00) (289+136)=(425) Profit After Tax 33.00 425.00 Depreciation 1000.00 1000.00 Cash Flow 1033.00 1425+900=2325 PV Factor(@15%) 0.87 0.76 PV of Cash Flow 898.71 1757.70Related Questions
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