IAG PUC-Rio
1984
Disney executives
were analyzing
the release of
Pinocchio in video
format.
Project Cash
Flows
Prof. Luiz Brandão
2015
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Disney - Pinocchio
Disney - Pinocchio
• Project Assumptions:
• First released in 1939, Pinocchio was only the
second feature animation film of Disney.
– Movies and video projects are mutually exclusive.
– Estimated sales of video: 7.5 million copies.
• Typically, these films were re-released in movie
theaters every 7 to 8 years.
• Results:
– Movies Project Value: $ 25 M
• In 1984 a new Disney management team was
discussing the re-release of this classic film.
– Video Project Value: $ 100 M
– Decision based on projected cash flow of each
alternative
• The question was whether they should also release
the film in video tape format.
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What happened
What happened
Disney – Videos Sales (million)
12,5
Disney - Videos Sales (million)
40,0
Bambi
The Lion King
Mogli
10,0
30,0
Cinderella
Alladin
Beauty and the Beast
7,5
20,0
5,0
2,5
Lady and the Tramp
Sleeping Beauty
Pinocchio
10,0
-
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86
87
88
89
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90
93
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Project Cash Flows
Project Cash Flows
• Depreciation
Incremental Flows
• Opportunity Costs
x
• Collateral effects
Total Flows
7
91
• Sunk Costs
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Project Cash Flows
• Working capital
• Indirect Costs
• Interest expenses
• Inflation
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Efeitos Colaterais – Canibalização
•
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Convention
One of the bigger surprises of Apple’s 2012 earnings
was the revelation that Mac sales declined.
Compared to the same quarter a year ago when it
sold 5.2 million Macs, Apple sold 22 percent fewer, or
4.1 million.
•
The quick explanation about why Apple sold fewer
Macs was that the iPad and new iPad mini were
favored by buyers
•
CEO Tim Cook explains:
•
“We know iPad is cannibalizing the Mac, but that
doesn’t worry us. On iPad in particular, we have the
mother of all opportunities here because the Windows
market is much larger than the Mac market. It’s clear
it’s already cannibalizing some. “I’ve said for three
years now that I believe the tablet market will be
larger than the PC market at some point, and I still
believe that.”
• Cash Flow representations
0
1
2
Continuous CF Continuous CF Continuous CF
Discrete Cash Flows
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Problems with Cash Flow
Projections
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Case Study:
Iridium Project
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• Original document
with the first
description of the
Iridium system
(1988)
• Collection:
Smithsonian
Museum,
Washington DC
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Iridium World Comunications
Iridium
• 1991: Motorola sets Iridium
as an independent company
through a "Project Finance"
to develop and operate the
network.
• Global mobile satellite
designed by Motorola
• Objective: To allow
access to the worldwide
phone network from
anywhere in the globe.
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• This allows other partners to
join the business, reducing
the risk for Motorola.
• Planned investment: $ 2.5 billion, including 66
communication satellites and seven ground stations.
• 1992: Iridium hires Motorola
for U.S. $ 3.37 billion to
develop, build and
implement the system.
• Forecast: 5 million subscribers by 2002
• Motorola becomes the main supplier of Iridium.
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The Consortium
• An International Consortium of
19 companies is formed to
make the project viable
– Motorola, Siemens, Raytheon,
HP
– Great Wall of China Industry
Corporation
– Khrunichev Space Center of
Russia
– Korea Mobile Telecomm
Corp.
– Lockheed, McDonnell
Douglas, Sprint
– Italian STET and 15 regional
operating franchises
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Project Financing
• With the establishment of
Iridium LLC and the entry of
new participants, Motorola
reduced its stake in the
business to 25%
• Large geographic and
technological diversity of the
participants.
• Project starts with equity investment
• 1993: Partners provided US$800 million
• 1994: $1.6 billion of equity, plus $800 million of debt.
• 1995: Iridium receives operating license
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Market &
Target Audience
Project Financing
• 1997: A $ 750 million line of credit is secured, and $240
million in company stock are offered to the public at a price
of $ 21 per share.
• In a few months the stock price rises to $ 70.
• Technical difficulties increase the project cost to $ 5.5
billion.
• Population of remote areas
with no other form of phone
service.
• 1998: All satellites already in orbit and commercial
operation begins
• Break even point: 600,000
subscribers needed by the end
of 1999.
• Launched a worldwide marketing campaign at a cost of
$160 million
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• Target Audience: Travelers
needing constant phone
access, such as businessmen
and professionals.
Problems
Problems
• Portable device availability delays delivery to subscribers.
• As a manufacturer, the
main goal of Motorola, as
sponsor of the project,
was to sell equipment.
• Connection problems because Iridium requires line of
sight to satellite, and thus does not work in closed areas
such as vehicles and offices.
• Marketing error by offering Iridium as a substitute to cell
phone.
• Iridium is a company that
provides services, which
is outside of Motorola´s
field of expertise.
• Service had significantly higher rates than the competitor
(about 10X greater), and phone weighted over one pound.
• High cost of service put
itout of reach part of their
target audience.
• Low quality analog signal when the phones were already
migrating to digital service.
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Problems
Conclusions
• Technical difficulties on an ambitious project substantially
increased costs originally budgeted.
• By July 1999 only 15,000
units had been sold.
• Marketing error when Iridium was sold as a substitute for
ordinary cell phones.
• The expected monthly
revenue of $30 million
was only $1.5 million
• Technological evolution on cell phones during the ten
years of maturation became a serious competitor to
Iridium, which is an analog system, with maximum speed
of 2400 baud.
• In July 1999, the shortterm debt was $800
million that the company
failed to honor.
• Actual Cash Flow different from initial estimates.
• The assets of Iridium LLC company, now bankrupt, were
bought by a group of private investors who founded
Iridium Satellite LLC operating system that continues to
this day.
• In August 1999, Iridium filed for bankruptcy, but failed to
recover and was declared bankrupt in March 2000.
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Ex 1:
Item
Year 0
Gross Revenues
Expenses
Exercises
Depreciation
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
4.000
10.000 15.000
15.000
15.000
10.000
(4.000) (6.000) (8.000) (8.000) (8.000) (6000)
(1.500)
(1.500) (1.500) (1.500) (1.500) (1.500)
EBIT
Tax (35%)
Net Income
Depreciation
Changes in WC (500)
(1.000) (1.000) (2.000)
(0)
2.000
2.500
CAPEX (3.000) (6.000)
Residual Value
2.000
Free Cash Flow
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SpectroMed Ltd.
Project
• Managers of SpectroMed are meeting with the shareholders to
decide on a new project investment opportunity.
• You are analyzing a project that has a total duration of 7 years.
The required investment is $600,000, with another $1.2 million
to be invested by the end of the third year of operation for a
projected expansion.
• If the project is implemented, the initial investment will be
$120,000 for the new facilities and $25,000 for working capital,
which will be fully funded by the shareholders.
• Depreciation is $200,000 per year, increasing to $300,000
starting in year 4. The incremental net revenue (revenue expenses) to be generated by this project is $400,000 per year,
before depreciation, increasing to $600,000 from year 4
onwards.
• The project has a four year life, gross revenues of $70,000 in the
first year and $ 200,000 in each of the remaining years, and a tax
rate of 25%. Costs represent 65% of gross revenue and
depreciation is linear during this period.
– If the company's cost of capital is 15% per year, and the tax rate is
35%, what is the NPV and IRR of this project?
• The shareholders expect a return of 20%. Do you recommend
investing in this project?
– Should the company invest in it?
– Graph the NPV for discount rates between 0 and 40%.
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IAG PUC-Rio
ErgoSoft
• Ergosoft is analyzing the feasibility of a five year project.
• The project requires an immediate investment of $600,000,
followed by another $900,000 by the end of the third year.
Project Cash
Flows
• The initial investment with be depreciated linearly in three years
at the rate of $200,000 per year, followed by a $450,000
depreciation in years 4 and 5. The net incremental revenues
(revenues – expenses) generated by the project are constant at
$400,000 per year before depreciation, and increase to
$600,000 per year from year 4 onwards.
• Assume that the firm´s cost of capital is 17% per year, and that
the tax bracket is 30%.
Prof. Luiz Brandão
• What is the NPV and IRR of this project? What is your
recommendation to the firm?
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•
2015
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