EFM-13problem - 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17...

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Page 1 13problem 3/22/2010 7:08 1/5/2006 Chapter 13. Solution to End-of-Chapter Comprehensive/Spreadsheet Problem Problem 13-14 Nevada Enterprises is considering buying a vacant lot that sells for $1.2 million. If the property is purchased, the company's plan is to spend another $5 million today (t = 0) to build a hotel on the property. The after-tax cash flows from the hotel will depend critically on whether the state imposes a tourism tax in this year's legislative session. If the tax is imposed, the hotel is expected to produce after-tax cash inflows of $600,000 at the end of each of the next 15 years. If the tax is not imposed, the hotel is expected to produce after-tax cash inflows of $1,200,000 at the end of each of the next 15 years. The project has a 12% WACC. Assume at the outset that the company does not have the option to delay the project. a. What is the project's expected NPV if the tax is imposed? WACC 12% Year Cash Flows 0 -6,200,000 1 600,000 2 600,000 3 600,000 4 600,000 5 600,000 6 600,000 7 600,000 8 600,000 9 600,000 10 600,000 11 600,000 12 600,000 13 600,000 14 600,000 15 600,000 NPV = -$2,113,481.31 Use NPV function to calculate, but remember to exclude Year 0 cash flow from Excel's NPV function and to add it separately to the Excel NPV result. b. What is the project's expected NPV if the tax is not imposed? WACC 12% Year Cash Flows 0 -6,200,000 1 1,200,000 2 1,200,000 3 1,200,000 4 1,200,000 5 1,200,000 6 1,200,000 7 1,200,000 8 1,200,000 9 1,200,000 10 1,200,000 11 1,200,000 A B C D E F G H I 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53
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Page 2 12 1,200,000 13 1,200,000 14 1,200,000 15 1,200,000 NPV = $1,973,037.39 c. Given that there is a 50% chance that the tax will be imposed, what is the project's expected NPV if they proceed with it today? Probability tax will be imposed 50% Probability tax will not be imposed 50% Expected NPV = ( Probability × NPV if tax imposed ) + ( Probability × Expected NPV = 50% × -$2,113,481.31 + 50% × Expected NPV = -$70,221.96 Because the project's expected NPV < 0, the firm would not do the project. d. While the company does not have an option to delay construction, it does have the option to abandon the project 1 year from now if the tax is imposed. If it abandons the project, it would sell the complete project property 1 year from now at an expected price of $6 million. Once the project is abandoned the company would no longer receive any cash inflows from it. Assuming that all cash flows are discounted at 12%, would the existence of this abandonment option affect the company's decision to proceed with the project today? Explain. Tax Imposed:
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This note was uploaded on 03/21/2010 for the course BUSINESS AB102 taught by Professor Woo during the Spring '10 term at Nanzan.

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EFM-13problem - 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17...

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