You’re considering investing in a project with the following characteristics: 1.

Question

You’re considering investing in a project with the following characteristics:

1.The investment of $400 can be depreciated to zero book value over 10 years.

2. EBITDA in year 1 is equal to $100, and from there on is expected to grow at 5% per year, every year, forever.

3. NWC requirements are $100 in year 0, and expected to remain constant forever.

4. The discount rate for all cash flows is constant and equal to 20% per year.

QUESTIONS:

A. Compute the NPV of the project if the tax rate is 0% per year. Is the IRR in this case higher or lower than 20%?

B. Compute the NPV of the project if the tax rate is 40% per year. Is the IRR in this case higher or lower than 20%?

A little explanation with your answer would be greatly appreciated!!

Explanation / Answer

Year Cash flow EBITDA Depriciation Net Cash Flow PV @ 20% Present Value Investment 0 -400 -$400.00 1 -$400.00 working capital 0 -100 -$100.00 1 -$100.00 1 $100.00 $40.00 $140.00 0.833333 $116.67 2 $700.00 $40.00 $740.00 0.694444 $513.89 3 $700.00 $40.00 $740.00 0.578704 $428.24 4 $700.00 $40.00 $740.00 0.482253 $356.87 5 $700.00 $40.00 $740.00 0.401878 $297.39 6 $700.00 $40.00 $740.00 0.334898 $247.82 7 $700.00 $40.00 $740.00 0.279082 $206.52 8 $700.00 $40.00 $740.00 0.232568 $172.10 9 $700.00 $40.00 $740.00 0.193807 $143.42 10 $700.00 $40.00 $740.00 0.161506 $119.51 NPV $1,982.92 IRR calculated with excel function IRR 65.39% IRR is greater than cost of capital 20% b. Year Cash flow EBITDA Depriciation EBIT EAT= EBIT x(1-40%) net cash flow = EAT + dep. PV @ 20% 0 -400 -$400.00 1 0 -100 -$100.00 1 1 $100.00 $40.00 $140.00 $84.00 $124.00 0.833333 2 $700.00 $40.00 $740.00 $444.00 $484.00 0.694444 3 $700.00 $40.00 $740.00 $444.00 $484.00 0.578704 4 $700.00 $40.00 $740.00 $444.00 $484.00 0.482253 5 $700.00 $40.00 $740.00 $444.00 $484.00 0.401878 6 $700.00 $40.00 $740.00 $444.00 $484.00 0.334898 7 $700.00 $40.00 $740.00 $444.00 $484.00 0.279082 8 $700.00 $40.00 $740.00 $444.00 $484.00 0.232568 9 $700.00 $40.00 $740.00 $444.00 $484.00 0.193807 10 $700.00 $40.00 $740.00 $444.00 $484.00 0.161506 NPV IRR EBIT from 2nd year = $100 x(1+5%)/(20%-5%) = $700 IRR is greater than cost of capital 20%

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