1 Revenue 1 Revenue

2 COGS 2 COGS
3=1-2 Gross Profit 3=1-2 Gross Profit
4 SG&A 4 SG&A
5=3-4 EBITDA 5=3-4 EBITDA
6 Depreciation and Amortization 6 Dep&Amortz
7=5-6 EBIT 7=5-6 EBIT
8 EBIT(1-t) 8 Less: Interest
Add: 6 Depreciation and Amortization 9=7-8 EBT
9 Less: Δ Investment in Working Capital 10 Less: Tax
10 Less: Δ Investment in Fixed Assets 11=9-10 Net Income
11 Add: Working capital Salvaged
12 Add: Fixed Assets Salvaged
13 FREE CASH FLOWS TO FIRM
South India Paper Mills is examining a five year life project on which the
Initial Investment in Plant will be Rs 45 crores and the Investment in W/C
will be Rs 5 crs. This is a paper recycling project on which the revenues the
first year is expected to be Rs 50 crores and the revenues are likely to increase
by 20% . Pa. In the third year of the project , Plant will have to be purchased
at Rs 2 crores. Investment in Plant will be depreciated to zero book value by the
end of the project life. Working capital to Revenues will have to be maintained by
reinvestment upfront at the beginning of the year. 95% of working capital will be
salvaged. The Rate Tax is 35% and the EBITDA margin is estimated at 65% of
revenues.
The Project will be funded as follows
Internal Equity 20%
New Issue of Equity30%
Preference Sh 10%
Debt 40%
The 5 year T Bond trades at 9.1% and the Market is expected to return 16%
The beta of paper projects ( unleavered ) is .85
New Issue of Equity has a floatation cost of 5%
Preference Shares will carry a preference dividend at the rate of 12%.
Debt will be sourced from IFCI and interest rate will be 17%.
Required 1. Cash Flows on the Project 2. Hurdle Rate on the Project 3. NPV and IRR

W/C 5 6 7.2 8.6 10.4

0 1 2 3 4 5
Revenues 50 60 72 86 104
EBITDA 33 39 47 56 67
Less: Depreciation 9 9 9 10 10
EBIT 24 30 38 46 57
EBIT(1-t) 15 20 25 30 37
Add: Dep 9 9 9 10 10
Less: Δ Investment in W/C 1 1 1 2
Less: Δ Investment in F/A 2
Add: W/C Salvaged 9.88
FCFF 23 27 30 38 57
DCF 112 20 21 20 22 29
Less: IO 50
NPV 62 Levered Beta= 1.22
Rf 9.10%
Rm 16%
Internal Equity 20% ke 17.51%
New Issue of Equity 30% New ke= 18.43%
Preference Sh 10% kp= 12%
Debt 40% kd= 11.05%
WACC= 14.65%
Therefore the firm must accept the project because the firm value will
increase by 62 crores.

The firm must reject this project because it will destroy shareholders
wealth by decreasing the firm value by 32 crores.
V and IRR
A Factory has an installed capacity to manufacture 50000 racquets and currently
it manufactures only 20000 Tennis racquets. The firm wants to divert 50%
of the capacity to manufacture 25000 squash racquets. An Average Tennis
racquet costs $ 40 to make and sells for $100.
Tennis racquets is a growing market growing by 10% p.a but squash racquet
is a stable growth market. The Tax rate is 40% and the Discount rate on
the project is 11%, compute the opportunity cost of diverting the production

Opportunity: Cost of foregone alternative.

60
Potential Lost Lost post tax
Sales Sales profit PV $36
0 20,000
1 22,000
2 24,200
3 26,620 1620 $58,320 $42,643
4 29,282 4282 $154,152 $101,545
5 32,210 7210.2 $259,567 $154,040
6 35,431 ### $375,524 $200,770
7 38,974 ### $503,076 $242,311
8 42,872 ### $643,384 $279,181
9 47,159 ### $797,722 $311,849
10 50,000 25000 $900,000 $316,966
$1,649,306
A firm is examining a five year life project with an initial investment of Rs 5 lacs
on which the Annual after tax cash flows is expected to be Rs 3 lac.
Apart from the initial investment in plant the project will also use some
other resources already owned by the firm
a) Two workers covered by a union contract which means that they cant
be fired for the next two years each on an annual salary of Rs 80000
will be transferred to this project.
b) A packaging plant already owned by the firm which has excess capacity
will be used for this project thus causing us to replace the packaging
plant at the end of the third year rather than the pre planned eight year
at a cost of Rs 2.5 lacs
c) A van, book value of Rs 50000 already owned by the firm on which
it is claiming annual depreciation of 10% will also be used for the project
thus loosing Rs 10000 annual rental it would have otherwise have earnt.
The Tax rate is 30% and the Discount rate on the Project is 9%.
Required Compute
a) Opportunity cost if any associated with using the workers, packaging
plant and the van.
b) NPV on the project.

1 2 3 4 5 6 7 8
Salary 112000 112000 112000
### ### ### ###

Packaging Plant 250000 250000

67579.3 ### ###
Van
PMT 7000
n 5
i 9%
PV of Annuity ###
Annual Cash Flow 300000
n 5
i 9%
PV of Annuity ###
NPV= ### minus 500000 minus ###
###
A grocery store wants to stock garden tools and seeds in the spare
space they have in the store. The racks will cost Rs 2 lacs and the
annual cash flow from sale of seeds and garden inmpements will be
Rs 50000. The gardening enthusiasts who will visit the store will also
buy other products thus increasing the Annual cash flow of other items
by Rs 10000 p.a. The store is expected to last 5 years and the discount
factor is 9%. Should we sell garden implements?
PMT 50000 10000
n 5 5
i 9% 9%
PV of Annuity ### ###
NPV= ### plus 38896.51 less 200000
###

You are wanting to offer baby sitting services in a mall to allow parents
to shop for longer. The service will cost Rs 4 lacs to set up and
will cost annually Rs 100000 to run. The tax rate is 30%.
This is a free service and the parents will not pay anything. However
the Annual Operating Income of the mall is expected to increase by
Rs 2 lac per annum and the mall is expected to last eight years.
Should you offer this service?

Δ EBIT of the mall 200000

Less: Δ Cost 100000
Δ EBIT of the establishment 100000
EBIT(1-t) 70000
Add: Depreciation 50000
CFAT 120000
n 8
i 9%
PV of Annuity ###
Less: IO 400000
NPV ###