Practice problems valuation

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University of Calgary *

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447

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Finance

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Feb 20, 2024

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Uploaded by AgentHeat3954

1. Kurl-up and Fry Inc. developed a coin operated “formulate fertilizer yourself (FFY)” vending machine for gardeners who want to get supplies at the local mall. The company believes it can sell 200, 400 and 500 units in the 1 st through 3 rd year. Each unit will sell for $12k, variable costs are $7k/unit, annual fixed manufacturing and marketing costs are $800k. The company anticipates net working capital investment will be 20% of the increase in next years anticipated sales, 80% of the NWC will be recovered at the end of the project. New plant and equipment cost $1.2 mm (CCA rate is 30%). The plant and equipment will be sold for its UCC balance at the end of the 3 rd year. Kurl-up’s tax rate is 35% and they demand a 12% return on such investments. What is the NPV and IRR? 2. Gracie Enterprises is contemplating a major expansion of its productive capacity. The expansion requires that land be purchased immediately for $150,000. A building would be constructed at a cost of $1.2 million payable a year from now. Machinery costing $250,000 would be purchased two years from now. Net cash inflows (EBITDA) from production, before taxes, are expected to start in the third year at $600,000 annually (excluding tax shields from CCA) and last until the 10th year. All cash flows occur at the end of each year. CCA rate on the building and machinery are 5% and 30% respectively, assets are amortized after they are paid for (i.e. the first amortization expense for the building is claimed at the end of year two and for the machinery at the end of year three). Building and machinery will be sold for their UCC values at the end of year 10. The company anticipates the land will be sold for it’s original purchase price (there is some remediation costs, these will be the responsibility of the future buyer). The company’s tax rate is 45% and it requires a 16% return on investments of this type. Is this a good investment? What is the NPV and IRR? 3. WBC Inc. is considering a new product line that requires production equipment costing $200,000 (CCA rate is 20%), construction of a new storage building that will cost $60,000. The building will be constructed on a lot the company purchased 5 years ago for $30,700. The market value of the land is $150,000. CCA rate on the building is 4%. The new production will result in an increase of $19,000 in NWC at the end of year 1, this amount will be recovered at the end of the projects 10 year life. Last year WBC spent $50,000 in R&D in anticipation of this project, the company is unsure if it can use the design. The marketing department anticipates new product sales of 1,000 per year. Units will sell for $600 each, production costs are $360 per unit. The marketing department also anticipates some cannibalization of the old product line - roughly 3% of new product sales come from the old product line sales. The new line will result in additional administrative overhead of 2% of total revenue and the company anticipates 10 years of production. In 10 years time the building will be worth $40,721, the equipment will be worth $24,159. The land will be worth $250,000. Tax rate for WBC is 34%, the company applies a 15% return to such new investments, Is this a good project?

4. Skunk Technology Inc. projects unit sales for a new product they're producing as follows: YearUnit Sales 1 137,000 2 130,000 3 134,000 4 143,000 5 146,000 Production will require immediately $689,000 in net working capital, and additional net working capital investments each year equal to 25% of the projected sales increase for the following year (note: if sales fall in the following year, there will be no NWC cash flow). The working capital will be recovered at the end of the fifth year. Total fixed costs are $154,000 per year, variable production costs are $269 per unit, and the units are priced at $347 each. Equipment needed for production has an installed cost of $15,200,000 today. The CCA on this machinery is 30%, and Skunk Technology Inc. pays 40% tax. They require a 26% rate of return on all projects such as this. At the end of the project, they will be able to sell this equipment for its UCC (after taking CCA for the year). Based on these preliminary project estimates, answer the questions below. a. What is the NPV and IRR of this project? b. Assuming the company is concerned that the fixed cost figure was incorrect, what level of annual fixed costs could the project incur that would result in a zero NPV? 5. Adapted from Lasher, Hedges and Fegarty “Practical Financial Management” p 466 – 467. Paxton Homes is a successful builder of moderate to high-priced houses. The company is considering an expansion into light commercial construction in which it would build shopping centers and small office buildings. Management considers the idea a new venture because of the major differences between commercial and residential construction. An investment of $12.5M in equipment is required to get into the new line of business, a further $3M in expenses will be paid. These additional expenses are to be immediately expensed, they are tax deductible. The CCA rate on the equipment is 30%. The equipment will be worthless at the end of eight years – ignore any terminal loss at that time. Part of the start-up money will come from the sale of some old trucks and cranes that have a total market value of $1.8M and an NBV of $600K. Selling the equipment will result in a reduction of $200K per year in amortization expense for 3 years. Revenue from the new line is expected to be $6M in the first year and to grow by $2M in each succeeding year until it reaches $20M. After that growth is uncertain and may be anywhere from 0 to 6% per year. Costs and expenses, including incremental overhead, will be 110% of revenues in the 1 st year, 85% in the next two years, and 70% thereafter. Economies of scale in materials purchasing

are expected to save the residential business about $250K per year but not until the 4 th year. Net working capital requirements are estimated at 10% of revenue. Assume these changes will not be recovered at the end of the project. The combined tax rate on the incremental business will be 40%. Losses can be offset against other profits and can therefore be viewed as earning a tax credit at the same rate. Paxton's cost of capital is 12%. Establish a base case analysis of this proposal using the information given. That is, forecast into the future until the numbers stop changing (8 years). Assume a terminal value based on a continuation of the eighth year's cash flows with no further growth. Is the project acceptable based on NPV and IRR given these assumptions?

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