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Unformatted text preview: ms. Subtracting the costs from the revenues will give us the value of the firm’s cash flows. We must calculate the present value of each separately since each is growing at a different rate. First, we will find the present value of the revenues. The revenues in year 1 will be the number of bottles sold, times the price per bottle, or: Aftertax revenue in year 1 in real terms = (2,100,000 × $1.25)(1 – 0.34) Aftertax revenue in year 1 in real terms = $1,732,500 Revenues will grow at six percent per year in real terms forever. Apply the growing perpetuity formula, we find the present value of the revenues is: PV of revenues = C1 / (R – g) PV of revenues = $1,732,500 / (0.10 – 0.06) PV of revenues = $43,312,500 153 The real aftertax costs in year 1 will be: Aftertax costs in year 1 in real terms = (2,100,000 × $0.75)(1 – 0.34) Aftertax costs in year 1 in real terms = $1,039,500 Costs will grow at five percent per year in real terms forever. Applying the growing perpetuity formula, we find the present value of the costs is: PV of costs = C1 / (R – g) PV of costs = $1,039,500 / (0.10 – 0.05) PV of costs = $20,790,000 Now we can find the value of the firm, which is: Value of the firm = PV of revenues – PV of costs Value of the firm = $43,312,500 – 20,790,000 Value of the firm = $22,522,500 17. To calculate the nominal cash flows, we simple increase each item in the income statement by the inflation rate, except for depreciation. Depreciation is a nominal cash flow, so it does not need to be adjusted for inflation in nominal cash flow analysis. Since the resale value is given in nominal terms as of the end of year 5, it does not need to be adjusted for inflation. Also, no inflation adjustment is needed for either the depreciation charge or the recovery of net working capital since these items are already expressed in nominal terms. Note that an increase in required net working capital is a negative cash flow whereas a decrease in required net working capital is a positive cash flow. We first need to calculate the taxes on the salvage value. Remember, to calculate the taxes paid (or tax credit) on the salvage value, we take the book value minus the market value, times the tax rate, which, in this case, would be: Taxes on salvage value = (BV – MV)tC Taxes on salvage value = ($0 – 40,000)(.34) Taxes on salvage value = –$13,600 So, the nominal aftertax salvage value is: Market price Tax on sale Aftertax salvage value $40,000 –13,600 $26,400 154 Now we can find the nominal cash flows each year using the income statement. Doing so, we find: Year 0 Sales Expenses Depreciation EBT Tax Net income OCF Capital spending NWC Total cash flow –$305,000 –10,000 –$315,000 Year 1 $230,000 60,000 61,000 $109,000 37,060 $71,940 $132,940 Year 2 $236,900 61,800 61,000 $114,100 38,794 $75,306 $136,306 Year 3 $244,007 63,654 61,000 $119,353 40,580 $78,773 $139,773 Year 4 $251,327 65,564 61,000 $124,764 42,420 $82,344 $143,344 Year 5 $258,867 67,531 61,000 $130,336 44,314 $86,022 $147,022 26,400 10,000 $183,422 $132,940 $136,306 $139,773 $143,344 18. The present value of the company is the present value of the future cash flows generated by the company. Here we have real cash flows, a real interest rate, and a real growth rate. The cash flows are a growing perpetuity, with a negative growth rate. Using the growing perpetuity equation, the present value of the cash flows are: PV = C1 / (R – g) PV = $155,000 / [.11 – (–.05)] PV = $968,750.00 19. To find the EAC, we first need to calculate the NPV of the incremental cash flows. We will begin with the aftertax salvage value, which is: Taxes on salvage value = (BV – MV)tC Taxes on salvage value = ($0 – 15,000)(.34) Taxes on salvage value = –$5,100 Market price Tax on sale Aftertax salvage value $15,000 –5,100 $9,900 Now we can find the operating cash flows. Using the tax shield approach, the operating cash flow each year will be: OCF = –$7,500(1 – 0.34) + 0.34($63,000/3) OCF = $2,190 So, the NPV of the cost of the decision to buy is: NPV = –$63,000 + $2,190(PVIFA12%,3) + ($9,900/1.123) NPV = –$50,693.37 155 In order to calculate the equivalent annual cost, set the NPV of the equipment equal to an annuity with the same economic life. Since the project has an economic life of three years and is discounted at 12 percent, set the NPV equal to a threeyear annuity, discounted at 12 percent. EAC = –$50,693.37 / (PVIFA12%,3) EAC = –$21,106.13 20. We will calculate the aftertax salvage value first. The aftertax salvage value of the equipment will be: Taxes on salvage value = (BV – MV)tC Taxes on salvage value = ($0 – 80,000)(.34) Taxes on salvage value = –$27,200 Market price Tax on sale Aftertax salvage value $80,000 –27,200 $52,800 Next, we will calculate the initial cash outlay, that is, the cash flow at Time 0. To undertake the project, we will have to purchase the equipment. The new project will decrease the net working capital, so this is a cash inflow at the beginnin...
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This note was uploaded on 07/10/2010 for the course FIN 6301 taught by Professor Eshmalwi during the Spring '10 term at University of TexasTyler.
 Spring '10
 eshmalwi
 Finance, Corporate Finance

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