Next year’s numbers include these: EBIT = 1,000 Depreciation = 250 Taxes = 100 N

Question

Next year’s numbers include these:

EBIT = 1,000                  Depreciation = 250          Taxes = 100        

Net increase in Working Capital = 50

Net Increase in Capital Expenditure = 250

Long-term sustainable growth = 4%

Risk free rate = 3%                     Beta = 1.5%

Equity Risk Premium = 7%

D/E = 0.333

Investment = -$10,000           (occurs at time = 0)         

Cost of debt (prior to tax adjustment) = 7%

Corporate tax rate = 33%

FIND:    Net Present Value (NPV). Use CFFA for cash flow and WACC for the discount rate.

Explanation / Answer

Cash flow = CFFA = EBIT -Taxes -change in working capital -net increase in capital expenditure

=1000-100- 50- 250

= 600

Cost of Equity =riskfree rate + Beta *equity risk premoum

= 3% + 1.5% * 7%

=13.5%

Cost fo debt = 7%*(1-.33)

=4.69%

D/E = 0.33

= E/(E+D) = 1/1.33 =0.25

D/(E+D) = 0.75

Hence wacc =0.75*13.5% +0.25*4.69% =11.29%

Hence value = = CFFA/(wacc-g)

= 600/(.1129 - .04) = 8221.994

NPV = -10000 +8221.94

which is negative at -1774.01

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