Name: Saurabh Singh RAWAT MIB 33 (Group B) - 122030

29.November.2012

Corporate Finance: Computer based Assignment

1. Your firm owns a Volkswagen dealership, and you are considering entering into a 5-year agreement to also sell Audi A4s. The car would cost $26,000 and you believe that you can sell 50 Audis per year at an average price of $30,000. You would have to hire 2 new sales people that you would pay $30,000 per year each year plus 5% of the revenue they generate. Audi would require that you invest $200,000 (depreciable straight line over 5 years) in Audi-related signage, equipment and furniture to place in your dealership. You would also be required to invest in 20 cars to keep in inventory over the life of the project. After 5 years, you can recover your investment in working capital, and the unneeded equipment would have a market value of $50,000. Your firm requires a 12% return on all new investments and the corporate tax rate is 40% and Capital gain tax rate is 20%. a) Calculate Payback period of the project c) Calculate IRR of the project b) Calculate NPV of the project d) Calculate PI of the project

e) Make a detail comment on the project commerciality and all the above economic decision making techniques. Solution: Given the information, and considering that the total salary paid to the two sales people is $30,000 combined per year, and considering a capital gain tax of 20% on the sale of asses the end of the 5th year, following are my calculations to find NPV, IRR, PI and Payback period of the project. (worked on Excel)

Payback period was calculated as below:

NPV Net Present Value

It is a summation of all the cash flows in a project, incoming and outgoing, taken at their present value and subtracting the initial investment made.

Where CF is the Cash Flows in present time, r is the discounted rate I is the initial investment t is the time period

It gives us a good understanding of how much a particular project is worth in present time. If NPV greater or equal to zero, one usually accepts the project If NPV less the zero, one usually rejects the project, as it

In my solution I found that the NPV is $ -139,092, which is negative. Which means we this project must be rejected. IRR Internal rate of Return

Its the rate at which NPV becomes 0. For investment purpose, a private equity investor will look for an IRR at least 10%. The capital gain is 12% and the IRR in our problem is 6.71% which is very low. The project should not be accepted.

PI Profitability Index

This measures the relation between the future wealth and the amount invested. Which is equal to the sum of cash receivable over the amount invested. In our problem, PI = 0.81. Ideally it should be above 1, which means the project is profitable.

Payback period

The payback period cannot be calculated here as at no point in the 5 years, does the accumulated NPV become positive ------------------------------------------------------------------------------------------------------------------------------------2. The firm ABC acquired 5 years ago an equipment that was worth $200,000, depreciated on a straight-line basis over 5 years. This equipment was due to produce $50,000 units a year during 12 years. Today, its market value is estimated at $6,000. A new equipment, worth $300,000, should increase the annual production by $10,000 units at a lower cost. Depreciation for that equipment is also on straight-line basis over 5 years. Here is a comparative table of costs per units (in $):

ution: Based on the information, following were calculations were made The selling price per unit is $12. The market value of the new equipment after 7 years of use will be zero and it will have to be replaced then. The income tax rate and tax on capital gain is 35%. The working capital requirement of the company amounts to 1 month of sales. Calculate the net cash flows and the IRR of this replacement project and critically justify your comments.

Solution: According to the information given, following are my calculations: (worked on Excel)

The IRR in the problem here is as 5.24%

In this problem, we are asked to find out only the IRR. Because of the unavailability of factors like NPV, Profitability Index or the Payback Period, we depend on IRR to give us information on the viability of this project. Generally investors will look at an IRR of at least 10%. Here we have an IRR of 5.24% which is rather small. So in a no profit no loss situation, the cost of capital for the project should be 5.24%, and to make a profit it should be below this figure. I think because the project lasts for 7 years so it would be difficult to get cost of capital for a figure smaller than this. It thus seem, that this project may not be very interesting for the investors.