Corporate Finance: Project Valuation case In Tutorial Library

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TITLE: Corporate Finance: Project Valuation case



Provide solutions to the problems in Excel.

Submit two files in total: (i) an electronic version of the Excel file; and (ii) a corresponding PDF of the Excel solution. Put each problem subpart in a separate, labeled worksheet within the Excel file (subpart means 1a, 1b, 1c., etc.). Where appropriate, add any discussion, verbal explanations or assumptions within the worksheet—note that your answers should not be purely numerical. To receive full credit, your solution must show all steps. Format your worksheets professionally so it is easy for the reader to follow your logic. Be sure your name appears in the filenames and within the files.

1. You are considering constructing a new plant to process copper from a new mine. Last week, you paid a consultant $1 million for a report that contains the following information. The plant will cost $100 million upfront. Once built, it will generate sales of $30 million at the end of each year over the life of the plant (these cash flows start at t=1). Operating expenses are 50% of sales. You need inventory equal to 20% of sales. You will extend accounts receivable to customers equal to 10% of sales. Your suppliers will provide accounts payable credit equal to 15% of sales. The plant will be useless and the project ends 20 years after its start. At that point you will have to pay an expected $150 million to shut down the plant and restore the area around the plant to its original state. All working capital items are 100% recoverable at the end of the project. You were not given the appropriate discount rate for the project, but you do have the following information for a firm in exactly the same business. In the Excel spreadsheet provided (downloadable from ELearning and also attached to this exam), you have 60 months of that company’s stock returns along with the corresponding overall stock market returns. That firm is financed with 50% equity and 50% risk-free debt. Its tax rate is 35%. The annual risk-free rate is 5% and the expected annual return on the overall stock market is 10%.

a. Compute the NPV of the project, including all necessary inputs.

b. Compute the IRR(s) of the project.

c. Should you move forward with the project? Explain in detail how your analyses in parts (a) and (b) factor into your recommendation. You are encouraged to use graph(s) to help illustrate your points.

2. You have been asked to evaluate a potential investment project. Last week your firm paid a consultant $400,000 for a report that contained the following forecasts. The initial investment in plant & equipment is $1 billion. The plant will be depreciated using MACRS rates for a 10-year asset (see table on p. 216 in Berk and DeMarzo). Assume the first depreciation expense occurs at t=1. At the end of the 10th year, the plant will have a salvage value of $300 million. Forecasted annual revenues are $200 million for each of the next 10 years. Operating expenses are 75% of revenues. The project requires $50 million in inventory at the start (t=0) and will require that level until the end of the project. Suppliers will provide financing via accounts payable for 40% of the inventory on an ongoing basis. All working capital is recoverable in year 10 when the project shuts down. Corporate headquarters will allocate an overhead charge to the project equal to $1 million per year, but you know that headquarters’ staffing and other costs will not actually change whether your firm accepts or rejects the project. The corporate tax rate is 35%.

a. If the risk-free rate is 5%, the expected return of the market is 10%, and the asset beta for the consumer electronics industry is 1.25, what is the NPV of the project?

b. Assume that you can finance $600 million of the cost of the plant using 10-year, 8% coupon bonds sold at face value. This new debt is tied specifically to this project and would not change other aspects of the firm’s capital structure. What is the value of the project, including the tax shield of the debt?

c. Explain in detail when you would use each of the two calculations (parts (a) and (b)) you made.

d. Given the information in (a) and (b) above, what return would you require if you were an equity investor in a similar consumer electronics firm that was financed with $500 million in debt, $400 million equity, and $50 million in excess cash? (This firm would have the same debt financing terms described in part (b)).

e. In words, how do the values in (a) and (b) differ from what one would get using the flow-to-equity (FTE) method to evaluate the project? Again in words, how exactly would the FTE calculation differ from the calculations in (a) and (b)?


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