Fin534

Problem twenty-three states the following:

"Bauer Industries is an automobile manufacturer. Management is currently evaluating a proposal to build a plant that will manufacture lightweight trucks. Bauer plans to use a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental free cash flow projections (in millions of dollars):

Year 0 Years 1 - 9 Year 10

Revenues 100.0 100.0

- Manufacturing expenses

(other than depreciation) -35.0 -35.0

- Marketing expenses 10.0 -10.0

- Depreciation -15.0 -15.0

= EBIT 40.0 40.0

- Taxes (35%) -14.0 -14.0

= Unlevered net income 26.0 26.0

+ Depreciation +15.0 +15.0

- Increases in net working capital -5.0 -5.0

- Capital expenditures -150.0

+ Continuation value +12.0

= Free cash flow -150.0 36.0 48.0

(Berk & DeMarzo, 2010).

a. For this base-case scenario, what is the NPV of the plant to manufacture lightweight trucks?

The NPV of the estimate free cash flow is $57.3 million

NPV = -150 + 36 x 1 ( 1 - 1 ) + 48 = $57.3 million

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b. Based on input from the marketing department, Bauer is uncertain about its revenue forecast. In particular, management would like to examine the sensitivity of the NPV to the revenue assumptions. What is the NPV of this project if revenues are 10% higher than forecast? What is the NPV if revenues are 10% lower than forecast?

If revenues are 10% higher than forecast:

Revenues are 10% higher

Year 0 Years 1 - 9 Year 10

Revenues 110.0 110.0

- Manufacturing expenses

(other than depreciation) -35.0 -35.0

- Marketing expenses -10.0 -10.0

- Depreciation -15.0 -15.0

= EBIT 50.0 50.0

- Taxes (35%) -17.5 -17.5

= Unlevered net income 32.5 32.5

+ Depreciation +15.0 +15.0

- Increases in net working capital -5.0 -5.0

- Capital expenditures -150.0

+ Continuation value +12.0

= Free cash flow -150.0 42.5 54.5

The NPV is $94 million if revenues are 10% higher than forecast.

NPV = -150 + 42.5 x 1 ( 1 - 1 ) + 54.5 = $94 million

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If revenues are 10% lower than forecast:

Revenues are 10% lower

Year 0 Years 1 - 9 Year 10

Revenues 90.0 90.0

- Manufacturing expenses

(other than depreciation) -35.0 -35.0

- Marketing expenses -10.0 -10.0

- Depreciation -15.0 -15.0

= EBIT 30.0 30.0

- Taxes (35%) -10.5 -10.5

= Unlevered net income 19.5 19.5

+ Depreciation +15.0 +15.0

- Increases in net working capital -5.0 -5.0

- Capital expenditures -150.0

+ Continuation value +12.0

= Free cash flow -150.0 29.5 41.5

The