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 $80 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 28% marginal tax rate and a cost of capital of 6%. If the project is funded, the resulting Net Operating Profit BEFORE Depreciation & Taxes (think EBITDA) are given below.
For purposes of your initial analysis (parts a through d) assume that accounting depreciation and economic depreciation are the same.
Net Operating Profit BEFORE Depreciation & Taxes (EBITDA)
|
Year 1 |
$30,000,000 |
|
Year 2 |
$32,000,000 |
|
Year 3 |
$34,000,000 |
|
Year 4 |
$36,000,000 |
- 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
- What is present value of the cash flows for this project? Show your work. PV of CF =
- 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 =
- How does the present value of the Economic Profits compare to the NPV of the cash flows for the project? Does that surprise you? Explain
