Net Present Value Extra Points FINA 440 Due May 4 2016 Zoe Trunchbull has always

Question

Net Present Value Extra Points FINA 440 Due May 4 2016 Zoe Trunchbull has always wanted to enter the blueberry business. She has found a 50 acre piece of es that the immediate annual yield from yield through careful plant the bushes would be 200 crates, with an expectation that she can increase management by 10% per year up to a maximum of 400 crates per year. Each crate is estimated to sell for $400 for the next 5 years. She has talked to other producers and has decided that there is a 50% chance that the price in year 6 would rise to $500 per crate, a 20% chance the price would fall to $300, and a 30% chance that it will stay at $400. She plans to use the expected sales figure for planning for the years 6-10, but also thinks it will be a good estimate of ongoing revenues well into the future. In order to get started, Zoe must pay $300,000 for the land plus $40,000 for packing equipment. The packing equipment will be depreciated over 5 years with no salvage value expected. Land depreciated. At the end of the 10 years, Zoe plans to sell the business and move some place warm is not , are estimated to be $50,000 for the first year and Annual operating expenses, including a salary for Zoe increase by 5% every year after. She plans to spend $10,000 per year on promotional activities in the off seasons. Her marginal tax rate is 30%. She has spoken to a bank about a $200,000 loan at 10% and believes she should plan on a 15% return on the rest of her capital. 1. (25 points) Complete the base case cash flow projections for 10 years on the attached form. Label specific line items clearly and identify any assumptions you are making. (5 points) Calculate the WACC for Zoe's business (5 points) Determine an appropriate terminal value for the project. Explain your assumptions. (2 points) Determine the net investment and the base case net present value. Would you recommend that Zoe take on this project? Be complete in your explanation of your response. 2. 3. 4. 5. (8 points) What risk analysis would you perform before coming to a final decision about this investment? Discuss the specific assumptions in the case that are particularly risky or ones that are critical to the outcome of the analysis. 6. (5 points) What specific modifications to the plan would you recommend that might increase the likelihood that the business would be a success? Bonus: How much does she need to sell the business for after the 10 years to break even? 7.

Explanation / Answer

Net Investment 3,40,000 Cost 3,40,000 Installation 0 Mkg/Training/other 0 Initial Net Wc 0 Terminal value Cash flow inperpetuity(F) 73,104 Wacc 10.2941% Terminal value(=F/Wacc) 710148.4 Wacc(=10%*(200,000/340000)*(1-0.30)+15%*(140,000/340000) Discount rate Wacc 10.2941% TaxRate TaxRate 30% 0 1 2 3 4 5 6 7 8 9 10 Total Sales crates sold per year n(t)=20+n(t-1) 220 240 260 280 300 320 340 360 380 400 Price per crate p(yr6-10)=60%*500+20%*300+30%*400 400 400 400 400 400 480 480 480 480 480 Annual Revenue S=n*p 88,000 96,000 1,04,000 1,12,000 1,20,000 1,53,600 1,63,200 1,72,800 1,82,400 1,92,000 Operating Costs/year OpC(t)=1.05*OpC(t-1) 50,000 52,500 55,125 57,881 60,775 63,814 67,005 70,355 73,873 77,566 Other incremental cost/year IC=0 0 0 0 0 0 0 0 0 0 0 Oppeortuninty cost/other Oc=10,000 10,000 10,000 10,000 10,000 10,000 10,000 10,000 10,000 10,000 10,000 Depreciation d=40000/5         8,000         8,000        8,000        8,000         8,000 0 0 0 0 0 EBIT EBIT=S-OpC-IC-Oc-d 20,000 25,500 30,875 36,119 41,225 79,786 86,195 92,445 98,527 1,04,434 (=-Taxes Taxes =EBIT*30% 6,000 7,650 9,263 10,836 12,367 23,936 25,859 27,733 29,558 31,330 EBI EBI=EBIT-Taxes 14,000 17,850 21,613 25,283 28,857 55,850 60,337 64,711 68,969 73,104 (=+Depreciation) d=40000/5 8,000 8,000 8,000 8,000 8,000 0 0 0 0 0 (+/-chg in WorkingCapital w=0 0 0 0 0 0 0 0 0 0 0 (+/-capital expenses Capex=0 0 0 0 0 0 0 0 0 0 0 FreeCash flows FCF(t)=EBI+d-w-Capex 22,000 25,850 29,613 33,283 36,857 55,850 60,337 64,711 68,969 73,104 Discount Free cash flows with Wacc Presnet value of free cash flows PV(t)=FCF(t)/(1+Wacc)^t 19,946.67 21,249.85 22,070.80 22,491.31 22,581.96 31,024.89 30,388.88 29,550.35 28,555.06 27,441.94 Sum of Presnet value of free cash flows Sum(PV(t)'s) 2,55,301.69 (-Net Investment Net Investment 3,40,000.00 (+Present value of terminal value PV(Term)=Terminal value/(1+Wacc)^10 2,66,578.80 Net present value Sum(PV(t)'s)-Net Investment+PV(Term) 1,81,880.49 As NPV of project >0 Zoe should take on the project

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