Corporate Finance - Cash Flow Estimation - Class Exercise - 7

1. Company X has a capital structure which is based on 30 percent debt, and

70 percent common stock. The pre-tax cost of debt is 8 percent, and the
cost of common stock is 11 percent. The company's tax rate is 34 percent.
The company is considering a project that is equally as risky as the overall
firm. This project has initial costs of $250,000 and cash inflows of $94,000 a
year for three years. What is the projected net present value of this project?
2. Company X is deciding whether to expand its production facilities. The
management has projected the following cash flows for the first two years
Rs in Crores
Revenue
Cost of Goods Sold &
Operating Expenses
Depreciation
Increase in Working Capital
Capital Expenditure
Marginal Corporate Tax

Yr 1
125

Yr 2
160

40
25
5
30
35%

60
36
8
40
35%

a) What are the earnings for this project for years 1 and 2 assuming there
is no loans?
b) What are the free cash flows (FCFF) for this project for the first two
years?
3. Company X is considering a project about which the estimated Capex and
Opex are provided below:
Rs in Crores
Capital Expenditure

Yr 0
(75)

Yr 1
(75)

Yr 2
0

Yr 3
0

Working Capital

(20)

10

13

100
40
60
20
40
10
30
8
22
7.7
14.3

130
52
78
20
58
10
48
8
40
14
26

175
70
105
20
85
10
75
8
67
23.45
43.55

Revenue
Cost of Goods Sold
Gross profit
Operating Expenses
EBIDTA
Depreciation
EBIT
Interest
EBT
Tax
EAT

(a) Based on above compute the FCF for the project

(b) If the opportunity cost of the project is 15% should company X accept
the project?

4. Company X is considering a capital project about which the following

information is available:
Investment outlay on the project will be Rs. 10 crores which includes Rs.
2 crores of working capital
Project life is expected to be 5 years. At the end of the 5 years the fixed
assets will fetch a salvage value of Rs. 3 crores whereas the working
capital will be released
Project is expected to increase the revenue of the firm by Rs. 12 crore
every year. The increase in cost on account of project is expected to be
Rs. 8 crore per year. Effective tax rate will be 30%.
Plant and machinery will be depreciated at the rate of 25% per year on
written down value method
Compute the Free Cash Flow of the project for five years. If the opportunity
cost of the project is 15% should the company undertake the project?
Compute the above using the net salvage value in accordance with the
Indian tax laws.
5. Company X is determining the cash flow for a project involving
replacement of an old machine by a new machine. The old machine bought
a few years ago has a book value of Rs. 4.0 lakhs and it can be sold to
realize a post tax salvage value of Rs 5.0 lakhs. It has a remaining life of
five years after which its net salvage value is expected to be Rs. 1.6 lakhs.
The company is following a depreciation rate of 25% under the written
down value method. The working capital required for the old machine is Rs.
4.00 lakhs.
The new machine costs Rs. 16.0 lakhs. It is expected to fetch a net salvage
value of Rs. 8.0 lakhs after 5 years when it will be no longer required. The
depreciation rate is to be considered same as that of existing machine. The
net working capital required for the new machine is Rs. 5.00 lakhs. The new
machine is expected to bring a saving of Rs. 3.0 lakhs annually in
manufacturing costs (other than depreciation). The tax rate applicable to
the firm is 40%.
If the weighted average cost of capital is 15% then should the company
procure the new machine? (Incremental Principle)
6. Ram Singh has received an inheritance of Rs. 3 lakhs from his father. He is
currently working in materials management in a company, and his salary is
Rs. 36,000 per year. He is considering two alternative investments of his
inheritance:
Option 1: Deposit Rs. 3.0 lakh in a 13 year Term deposit at 15% interest p.a
and continue with the job.
Option 2: Purchase and operate a general store and leave the job

He has to spend Rs. 2.4 lakhs towards building and fixtures

including Rs. 1.0 lakh towrds merchandise. He also has to
invest Rs. 0.60 lakhs towwards working capital
Annual income expected - Rs. 3.9 lakhs per anum
Annual Expenses estimated - Rs. 3.0 lakhs per anum
At the end of 13 years he wish to retire and hence has
estimated the net salvage value of the store at Rs. 50,000
Personal Income tax - 30%
Which course of action would Ram Singh chose? Assume straight line
method for depreciation with life of asset as 13 years. Assume no growth in
the salary or the income from business of Ram Singh.
7. Company X is considering a project with an estimated cash flows as
provided in the Table below.
Yr 0
Yr 1
Yr 2
Yr 3
Yr 4
Yr 5
-10,000 3500
3500
3500
3500
3500
The opportunity cost of capital for the company was 15% (Nominal). Based
on the above would you recommend to accept the project.
It was realized later that while estimating the cash flows the inflation during
the period has not been considered which is expected to be 6%. Will your
decision change if you take inflation into consideration? (Consistency
principle)
8. Use MS Excel the solve the following question:
Company X is considering a new machine which cost is estimated as Rs.
2.5 crores. The annual capacity of the plant is 50,000 packets with market
price set at Rs. 140/packet. The variable cost per packet will be Rs.
85/packet.
The initial fixed cost would be Rs. 150 lakh which includes one time
promotion expenditure of Rs. 75 lakh in the first year. Written down
depreciation for tax purposes is 25%. Working capital requirement in the
beginning of the year is estimated to be 15% of the sales. The company
expects its revenue and costs to be affected by inflation which is expected
to be 4.6% per anum. The company expects that the plant capacity
utilization over its economic life of 5 years will be as follows:
Year
Capacity Utilization (%)

1
25

2
35

3
50

4
75

5
100

The terminal value of the project is estimated to be Rs. 25 lakh. Calculate

the project's NPV assuming a rate of return of 9%. The corporate tax rate is

35%. Assume that the depreciation is charged on the block of assets as per
the current tax laws in India.