Description
You have been retained as a consultant by a business that is considering production of a new product.
Thisproductionwouldrequireaninitialcapital outlayof$100million.Thiscapitalexpenditurecanbe depreciated(straight line) over a 4-year life of the project with no salvage value.Assume the firmfacesa 25% marginaltaxrate anda cost of capital of 9%. If the projectis funded,theresultingNet Operating ProfitBEFOREDepreciation & Taxes(thinkEBITDA) aregivenbelow.
Net Operating Profit BEFOREDepreciation & Taxes (EBITDA)
For purposes of your initial analysis (parts a through d) assume that accounting depreciation and economic depreciation are the same.
There are questions (a) through (f)
Unformatted Attachment Preview
PART II. Analysis of Value Creation (25 points)
You have been retained as a consultant by a business that is considering production of a new product.
This production would require an initial capital outlay of $100 million. This capital expenditure can be
depreciated (straight line) over a 4-year life of the project with no salvage value. Assume the firm faces a
25% marginal tax rate and a cost of capital of 9%. If the project is funded, the resulting Net Operating
Profit BEFORE Depreciation & Taxes (think EBITDA) are given below.
Net Operating Profit BEFORE Depreciation & Taxes (EBITDA)
Year 1
Year 2
Year 3
Year 4
$40,000,000
$42,000,000
$44,000,000
$46,000,000
For purposes of your initial analysis (parts a through d) assume that accounting depreciation and
economic depreciation are the same.
(a) Calculate the Cash Flow and Economic Profit for each year. Reminder, the “year 0″is included to capture
the initial outflow in the CF analysis. Show your work.
Cash Flow
Economic Profit
Year 0
Year 1
Year 2
Year 3
Year 4
(b) What is present value of the cash flows for this project? Show your work.
PV of CF =
(a) What is the present value of the stream of economic profits (assume that accounting depreciation and
economic depreciation are the same). Show your work.
PV of EP =
(b) Now assume that the market value of the capital does not decrease as suggested by “straight line”
accounting depreciation, but rather that the market value of the capital is given as listed below (in other
words, accounting and economic depreciation are not the same).
Market value at end of year 1
Market value at end of year 2
Market value at end of year 3
Market value at end of year 4
$40,000,000
$20,000,000
$10,000,000
$0
Based on this economic depreciation schedule, calculate the economic profit of the project.
Economic Profit
Year 1
Year 2
Year 3
Year 4
(e) What is the present value of this stream of economic profit? Show your work.
PV of EP =
_______
(c) If the tax code were changed to allow managers to “expense” their capital expenditure (in this context,
“expense” means take the full tax deduction from a capital expenditure immediately rather than
depreciate it), would the present value of cash flows rise or fall (assume any operating losses can be
carried forward)? Explain WHY?
PV of the Cash Flows would RISE or FALL (Circle one)
Purchase answer to see full
attachment
