There's No Such Thing as a Free Cash Flow
Formula for calculating the FCF at the end of a project.
FCF=(S-E-D)*(1-t) + D - DeltaNWC - DeltaPPE +- SideEffects + NSV + RecoveredNWC
Taco World Corporation has a capital structure of 40% debt and 60% common stock. The cost of debt for Taco World is 6%, and the cost of equity is 12%. The tax rate facing the company is 35%. What is the weighted average cost of capital for Taco World?
rWACC = 8.76%
rWACC = 40%*6%*(1-0.35) + 60%*12%
Depreciable basis of a piece of equipment that costs $50,000, has installation costs of $1,000, has moving costs of $500, and employee training costs of $800.
Depreciable Basis = $50,000+$1,000+$500=$51,500
Type of risk analysis where you adjust one variable to see the change in the final outcome.
What is sensitivity analysis?
Suppose a company decides to open a new branch in the next county. The after-tax cash flows for the new center are expected to be $15,000 per month. However, the new center will cause some customers to switch to the new branch creating a negative side effect. The lost membership fees from the original location are estimated at $2,000 per month. The after-tax operating margin on memberships is 60%.
What is the cash flow from the monthly side effect?
Side Effect = -$2,000*60% = -$1,200 per month
You have spent $2 million in project planning over the past and from these efforts, you have learned the following information. The project will require the purchase of equipment (5-year useful life) and $25 million. Employee training will cost another $5 million. The project will be operated for 4 years generating estimated annual sales revenues of $16 million and estimated annual expenses of $5 million. The tax rate for the project is 40%.
Suppose the firm will sell the equipment at year 4 and can get $8 million for it.
What are the taxes on the sale of that equipment?
Taxes on sale = t*(MV-BV) = 0.4*(8-5) = $1.2 million
A firm has a reported beta of 1.25. The risk-free rate in the economy is 2.25%, and the market portfolio risk premium is 5.5%. What is the required return to hold the firm's common equity?
rE = 9.13%
rE = 2.25% + 1.25*5.5%
Yearly depreciation for a piece of equipment with a depreciable basis of $2,000,000 and a useful life of 8 years that is depreciated using straight-line depreciation.
Yearly Depreciation = $2,000,000/8 = $250,000
Company A and Company B are very similar except Company A has higher fixed costs. Company _____ has a higher Beta.
A - higher fixed costs is associated with higher volatility and higher Beta
The working capital requirements for a 2-year project are as follow:
Year 0: Accounts Receivable = $0, Inventory = $100, Accounts Payable = $0
Year 1: Accounts Receivable = $100, Inventory = $100, Accounts Payable = $50
Year 2: Accounts Receivable = $150, Inventory = $100, Accounts Payable = $100
What is the investment in NWC for year 1?
Investment in NWC 1 = NWC1 - NWC0 = $150 - $100
NWC = CA-CL = (AR+Inv+Cash) - (AP+Accruals)
NWC0 = 0 + 100 - 0 = $100
NWC1 = 100 + 100 -50 = $150
You have spent $2 million in project planning over the past and have learned the following information. The project will require the purchase of equipment (5-year useful life) and $25 million. Employee training will cost another $5 million. The project will be operated for 4 years generating estimated annual sales revenues of $16 million and estimated annual expenses of $5 million. The tax rate for the project is 40%.
What is the FCF in time 0?
FCF0 = (0-5-0)*(1-.4)+0-0-25 = -$28 million
An analyst has collected the following data on Macro Corp’s financials.
Notes Payable: BV=$100,000, MV=$100,000
Long-term Debt: BV=$800,000, MV=$750,000
Preferred Stock: BV=$150,000, MV=$120,000
Common Stock: BV=$500,000, MV=$750,000
What is the weight in preferred stock in Macro Corp?
wP = 6.98%
Value of Firm = $100,000 + $750,000 + $120,000 + $750,000 = $1,720,000
wP = $120,000/$1,720,000 = 6.98%
What is the depreciation in year 3 of a piece of equipment that had a depreciable basis in year 0 of $150,000, has a useful life of 5 years, and is depreciated according to the 5-year MACRS schedule:
1 20%
2 32%
3 19.2%
4 11.52%
5 11.52%
6 5.76%
D3 = $150,000*19.2% = $28,800
A start-up technology company is trying to build a product that will compete directly with Groupon. A venture capitalist is being asked to provide $20 million in capital for the first round of funding. If the start-up is successful, the venture capitalist can exit the company in three years with $140 million (NPV today). If the start-up fails, the venture capitalist will exit the company in three years with a -$20 million loss (NPV today). The probability of success is expected to be 15%. What is the expected value of these two scenarios?
E(NPV) = $4 million = 0.15*140 + 0.85*(-20)
A firm just spent $4.00 million conducting a marketing survey. The survey looked at consumer interest in a new home gaming system. The firm has examined the results and will now invest $131.00 million in developing the new system.
What kind of cash flow is the $4.00 million spent on the marketing survey?
Sunk cost
You have spent $2 million in project planning over the past and have learned the following information. The project will require the purchase of equipment (5-year useful life) and $25 million. Employee training will cost another $5 million. The project will be operated for 4 years generating estimated annual sales revenues of $16 million and estimated annual expenses of $5 million. The tax rate for the project is 40%.
What is the FCF in time 1?
FCF1 = (16-5-5)*(1-0.4)+5-0-0 = $8.6 million
Amarillo Sky Incorporated issued a dividend this morning for $2 per share. Analysts expect dividends to grow at 4.25% per year going forward. The price of Amarillo Sky today is $8. What is the implied equity cost of capital based on this information?
rE = 30.31%
rE = ($2*1.0425)/$8 + 0.0425
What is the book value of a 3-year-old piece of equipment with a depreciable basis of $100,000 and 5-year useful life depreciated by the 5-year MACRS schedule:
1 20%
2 32%
3 19.2%
4 11.52%
5 11.52%
6 5.76%
BV=$100,000-$20,000-$32,000-$19,200=$28,800
Your little sister wants to be a lemonade entrepreneur this fall. The fixed cost of the lemonade stand will be $30. The variable cost of making one cup of lemonade will be $0.10. She will charge an aggressive $0.50 for one cup of lemonade. How many cups of lemonade need to be sold to break-even? (cash-flow break even)
Cash-flow break-even units = FC/(P-VC)
=$30/($0.50-$0.10)=75 cups of lemonade
A new restaurant franchise requires $50,000 in new cooking equipment for the kitchen. The equipment will be straight-line depreciated over 10 years. At the end of the 8th year, the owner expects to salvage (sell) the equipment for $5,000 on the secondary market. The marginal tax rate for the owner is 35%.
What is the Net Salvage Value (NSV) when the cooking equipment is sold after 8 years?
NSV = $6,750 = $5,000 - 0.35*($5,000 - $10,000) = MV - t*(MV - BV)
BV = $50,000 - 8*$5,000 = $10,000
Daily Double!
$772.65 million
A company has an outstanding bond issue that will mature in 15 years. It pays an annual coupon of 9% and trades at 90% of face value. What would be the cost of new debt (if it issues near par value)?
rD = 10.34%
n = 15
I/Y = ? = 10.34%
PV = -1000*90% = -$900
PMT = $90
FV = $1000
Daily Double!
$28,838.21
The projects you should accept if your budget is $10,000:
Project A: Investment=$4,000, NPV=-$400
Project B: Investment=$8,000, NPV=$1,000
Project C: Investment=$3,000, NPV=$2,000
Project D: Investment=$1,000, NPV=$200
Project E: Investment=$1,000, NPV=$800
What is accept E, D, and C?
Project B PI = 9000/8000 = 1.125
Project C PI = 5000/3000 = 1.6667
Project D PI = 1.2
Project E PI = 1.8
A firm will use an existing warehouse for a project. The firm can sell the warehouse today for $3.5 million (after-tax CF) if it rejects this opportunity. The project will last ten years, and the firm thinks the after-tax value of the warehouse will appreciate by 4% per year during that time. Ignoring taxes, what is the net opportunity cost of the warehouse if the cost of capital facing the firm is 15%?
Net opportunity cost today = -$3.5 + $5.18/(1.15^10) = -$2.22 million
Opportunity cost of warehouse today = -$3.5 million
Value of warehouse at end of project =$3.5*(1.04)^10 = $5.18 million