Classroom Projects
FIN600
Module 4
Please complete Problem 1. If you have time, attempt Problem 2, but it is more difficult.
1.
Elmer Fudd Bros. is thinking of setting up a plant making canned rabbit stew. The initial
investment is $1 million which is depreciated over the 10-year life of the plant on a straightline basis. Fudd management will close the plant down in 10 years. The plant has a salvage
value of $300,000 at that time. Working capital required is $350,000, which also must be
invested up front but will be recovered when the plant closes. Revenues minus costs (not
including depreciation) are $200,000 each year. The tax rate is 33.3%. What is the NPV of
the project if the discount rate is 10%
2. A blast furnace project
USX is considering adding an additional furnace, with an estimated useful life of 10 years.
Doing so involves the following changes in conditions:
i)
ii)
iii)
iv)
v)
vi)
Last year, a feasibility study was completed (your source of numbers) that will cost $1M.
New Plant will produce $150M in annual new sales.
Project saves $100M year in expenses.
Initial capital cost of furnace $1,000M
Operating costs of the new furnace will be $50M per year.
Furnace will use parts from old furnace. Old furnace is fully depreciated but has a resale
value after taxes (with parts) of $30M today. Without the parts the old furnace has no
value. The parts are no longer manufactured.
vii)
The new furnace is expected to have a salvage value of $200M at the end of ten years.
viii) The project will require an immediate increase in working capital of $20M, but thereafter
working capital will remain constant for the life of the project and will be recovered at the
end of the project.
Assume additionally that you face a 33.3% marginal tax rate and use straight-line depreciation
down to zero. (note: straight line means (cost/useful life). Assume that the cost of capital
(discount rate) is 10%.
Year
Sales increase
Expense decline
Operating costs
Capital
expenses
Opportunity
cost of your Old Plant
Change in NWC
Taxes (.333)
Net Cash flow
0
1
2
3
4
5
Calculate each row and find the NPV of the project
6
7
8
9
10