Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN: 9781260013924
Author: Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher: Mcgraw-hill Education,
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a) You are the CEO of a highly profitable firm and you expect the firm to remain
successful and profitable in the future. Currently, you are evaluating a new,
large investment project that could be initiated at the start of 2022. The project
involves the purchase of a real estate asset requiring an initial outlay of £650
million. You expect that, over the first five years of the project, its initial capital
investment should be fully depreciated. Your accountants have prepared the
following projections on expected sales and cash flows (in millions), and
information on the cost of capital of your company:
Table 1. Sales and cash flow projections
2022
2023
2024
2025
2026
Sales
EBITD
80
115
155
140
143
136
72
104
130
122
(130)
(58)
(10.44)
(47.56)
(130)
(8)
(1.44)
(6.56)
Depreciation
EBIT
(130)
10
(130)
(26)
(4.68)
(21.32)
(130)
Тах еxpensе
EBIAT
1.8
8.2
Table 2. Cost of capital
Risk-free Rate (Rf)
Project Cost of Debt (Rd)
Market Risk Premium
1%
4%
6%
Statutory and Marginal Corporate Tax 18%
Rate (Tc)
Asset
Beta
of
Comparable 0.8
Companies
Address the following questions, always assuming that cash flows occur at the
end of their respective years:
(i) Estimate the NPV of the investment project at the start of 2022, if it is
100% financed with equity and assuming that the project is terminated at
the end of 2026. Describe your calculations and comment on your
findings.
(ii) Use the WACC method to estimate the NPV of the investment at the
start of 2022, assuming that it is financed 25% with equity and 75% with
debt and that the project is terminated at the end of 2026. Describe your
calculations and comment on your findings.
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Transcribed Image Text:a) You are the CEO of a highly profitable firm and you expect the firm to remain successful and profitable in the future. Currently, you are evaluating a new, large investment project that could be initiated at the start of 2022. The project involves the purchase of a real estate asset requiring an initial outlay of £650 million. You expect that, over the first five years of the project, its initial capital investment should be fully depreciated. Your accountants have prepared the following projections on expected sales and cash flows (in millions), and information on the cost of capital of your company: Table 1. Sales and cash flow projections 2022 2023 2024 2025 2026 Sales EBITD 80 115 155 140 143 136 72 104 130 122 (130) (58) (10.44) (47.56) (130) (8) (1.44) (6.56) Depreciation EBIT (130) 10 (130) (26) (4.68) (21.32) (130) Тах еxpensе EBIAT 1.8 8.2 Table 2. Cost of capital Risk-free Rate (Rf) Project Cost of Debt (Rd) Market Risk Premium 1% 4% 6% Statutory and Marginal Corporate Tax 18% Rate (Tc) Asset Beta of Comparable 0.8 Companies Address the following questions, always assuming that cash flows occur at the end of their respective years: (i) Estimate the NPV of the investment project at the start of 2022, if it is 100% financed with equity and assuming that the project is terminated at the end of 2026. Describe your calculations and comment on your findings. (ii) Use the WACC method to estimate the NPV of the investment at the start of 2022, assuming that it is financed 25% with equity and 75% with debt and that the project is terminated at the end of 2026. Describe your calculations and comment on your findings.
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