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.
0 1 2 3 4 5
5,000 5, 000(1.02) 5, 000(1.02)
2
PV
=
5,000
0.100.02
For the account to be worth this much in two years, the amount that the entrepreneur needs
to contribute initially is
PV = PV
1
(1.10)
2
=
5,000
0.08
1
(1.10)
2
= 51,652.89.
3. The present value of what you get is given by
PV
+
=
10,000
0.12
_
1
1
(1.12)
5
_
= 36,047.76.
The present value of what you will have to pay back is given by
PV
=
10,000
0.12
_
1
1
(1.12)
10
_
1
(1.12)
5
= 32,060.88.
Since the present value of the money you will get is larger than that you will have to pay
back (PV
+
> PV
. We know that
I
= 2 + 6 = 8.
(e) Let the rm invest $6 millions in real assets; this leaves the shareholders with $4 millions
today. Then borrow $2 millions at 10% from period 1 (next year) consumption using
the capital markets; this provides shareholders with an additional $2 millions today, for
a total of $6 millions.
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(f) Next year, the rms real investments will have generated $8.8 millions, but the share-
holders owe 2(1.1) = $2.2 millions. Their consumption (spending) in period 1 will there-
fore be 8.8 2.2 = $6.6 millions.
7. We can forecast the unlevered net income for this project as follows (all numbers in 000):
End of year
0 1 2 3
Sales 5,000 5,500 6,500
Cost of Goods Sold -2,500 -2,500 -2,500
Gross Prot 2,500 3,000 4,000
General & Administrative -1,300 -1,300 -1,300
Depreciation -600 -600 -600
EBIT 600 1,100 2,100
Income Tax (35%) -210 -385 -735
Unlevered Net Income 390 715 1,365
To calculate the projects free cash ows, we need to add back depreciation, subtract capital
expenditures, and subtract annual changes in net working capital.
The initial capital expenditure is $2,400,000. In year 3, the equipment sale will generate
a positive cash ow of $800,000. The excess over the book value of the machine (2.4M
0.6M 0.6M 0.6M = 600,000) is considered a taxable gain. The tax is 35% (800,000
600,000) = 70,000. Therefore, the net capital inow from the sale of the machine in year 3 is
800,000 70,000 = 730,000.
The following table shows how the annual changes in net working capital are calculated:
End of year
0 1 2 3 4
Cash Requirements
Plus: Inventory
Plus: Receivables 500 550 650
Minus: Payables -250 -250 -250
Net Working Capital 250 300 400 0
Increase in NWC 250 50 100 -400
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The projects free cash ows are therefore as follows:
End of year
0 1 2 3 4
Unlevered Net Income 390 715 1,365
Plus: Depreciation 600 600 600
Minus: CapEx -2,400 730
Minus: Increase in NWC -250 -50 -100 400
Free Cash Flow -2,400 740 1,265 2,595 400
The projects net present value is
NPV = 2,400 +
740
1.16
+
1,265
(1.16)
2
+
2,595
(1.16)
3
+
400
(1.16)
4
= 1,061.
8. The solution spreadsheet is available on the Downloads section of the courses website. As
shown in this spreadsheet, the projects free ows are as follows:
End of year
0 1 2 3
Revenues 40,000 40,000 40,000
Operating Costs -3,000 -3,000 -3,000
Depreciation -30,000 -48,000 -28,000
EBIT 7,000 -11,000 8,200
Income Tax (35%) -2,450 3,850 -2,870
Unlevered Net Income 4,550 -7,150 5,330
Depreciation 30,000 48,000 28,800
Capital Expenditures -150,000 54,120
Free Cash Flow -150,000 34,550 40,850 88,250
The projects net present value is
NPV = 150,000 +
34,550
1.12
+
40,850
(1.12)
2
+
88,250
(1.12)
3
= 23,772.
Alternatively, one could calculate the projects NPV as
NPV =cost of equipment +PV (after-tax net operating prots)
+PV (depreciation tax shield) +PV (equipment sale) PV (tax on equipment sale).
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These PVs are calculated as follows:
PV (after-tax net operating prots) = (1 0.35)
40,000 3,000
0.12
_
1
_
1
1.12
_
3
_
= 57,764.04;
PV (depreciation tax shield) = 0.35(150,000)
_
0.2
1.12
+
0.32
(1.12)
2
+
0.192
(1.12)
3
_
= 29,942.60;
PV (equipment sale) =
60,000
(1.12)
3
= 42,706.81;
PV (tax on equipment sale) =
0.35
_
60,000 (1 0.2 0.32 0.192)150,000
(1.12)
3
= 4,185.27.
Again, this gives us NPV = 23,771.81 < 0. So Nalyd should not purchase this equipment.
9. The solution spreadsheet is available on the Downloads section of the courses website. To
nd the break-even price (of 60,019) using Excel, we make use of Goal Seek:
Without Excel, the calculations are as follows. The current book value of the old harvester is
50,000 5
_
50,000
10
_
= 25,000.
The incremental cash ow at t = 0 if the new harvester is purchased is therefore
C
0
= 20,000 + 0.34(25,000 20,000) P = 21,700 P
where we have have taken into account the tax eect of the book loss on the sale of the old
harvester. The incremental cash ow between years 1 and 5 equals the after-tax cost savings
plus the tax eect of the incremental depreciation:
C
t
= (1 0.34)10,000 + 0.34
_
P
10
5,000
_
= 4,900 + 0.034P (t = 1, . . . , 5)
After year 5, the old harvester would have been completely depreciated, so that the incre-
mental cash ow between years 6 and 9 is:
C
t
= (1 0.34)10,000 + 0.34
P
10
= 6,600 + 0.034P (t = 6, . . . , 9)
Finally, the incremental cash ow in year 10 reects the incremental salvage value of the new
harvester and the consequent tax increase:
C
10
= (1 0.34)10,000 + 0.34
P
10
+ (5,000 1,000) 0.34(5,000 1,000)
= 9,240 + 0.034P
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The NPV of the project is then:
NPV =
10
t=0
C
t
1.15
t
= 21,700 P +
4,900 + 0.034P
0.15
_
1
1
(1.15)
5
_
+
6,600 + 0.034P
0.15 (1.15)
5
_
1
1
(1.15)
4
_
+
9,240 + 0.034P
(1.15)
10
= 49,778 0.829P.
Setting NPV = 0 and solving for P gives P = 60,019. This is the maximum price that
Conocococonut would be willing to pay for the new harvester.
10. See solution spreadsheet posted on the Downloads section of the courses website.
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