Below id the problem and what I have completed so far. I am at a loss at this po

Question

Below id the problem and what I have completed so far. I am at a loss at this point

Tom Osborne, the CFO of Huskers Private Equity Fund, is reviewing an acquisition opportunity for the fund. Mr. Osborne is considering whether Huskers should buy the firm XYZ. XYZ is currently for sale at the book value of its equity (i.e. $30,000 to be paid immediately). Huskers investment guidelines require that each investment should earn at least 40% per year. Investment horizon in XYZ is 7 years. At the end of the 7th year (i.e. t=7 or year 2021), Huskers expects to sell XYZ at a price that is 8 times the firm's free cash-flow in 2021. Using the assumptions given below, answer the following questions:

1- What is the NPV of this acquisition given Huskers required return of 40%?

2- What is the IRR of the proposed investment?

3- Should Mr. Osborne recommend buying XYZ?

- Annual revenue growth rates will be -10%, 20%, 20%, 40%, 75%, 30%, 20% during the next seven years respectively.

- COGS will be 75% of the annual revenues.

- Depreciation expense will be 10% of gross PP&E.

- XYZ will make $25,000 per year in additional capital investments during the next seven years.

- Interest rate on debt is 10% and the annual interest expense is computed as 10% of the average of the current year’s and the previous year's interest bearing debt balance (= long-term debt).

- Minimum cash balance should be at least $5000 every year.

- XYZ will pay the maximum dividends as long as there is no equity issuance during the fiscal year. In other words, there cannot be a dividend payment during a fiscal year if XYZ needs equity funding during that fiscal year. Dividend payments out of XYZ is a cash inflow for Huskers.

- Accounts receivable will be 60% of annual revenues.

- Accounts payable will be 60% of annual revenues.

- No new debt will be issued. Long-term debt is due seven years from now (i.e. t=7 or year 2021). The principal amount of $20,000 will be paid as of the 2021 fiscal year end.

- XYZ will issue equity as needed. Since Huskers is the sole owner of XYZ, XYZ's equity issuance is funded by Huskers (i.e. from Huskers' perspective any equity issuance by XYZ is a cash outflow or equivalently additional investment contribution in XYZ ). Huskers' investment guidelines permit contributing at most $100,000 in XYZ during the next 7 years (including the $30,000 acquisition price). Any dividends that are paid out reduce the total amount contributed.

2014 2015 2016 2017 2018    2019    2020 2021 Revenue $      50,000.00 $      45,000.00 $    54,000.00 $    64,800.00 $    90,720.00 $ 158,760.00 $ 206,388.00 $ 247,665.60 COGS (Excludes depreciation expense) $      36,750.00 $      33,750.00 $    40,500.00 $    48,600.00 $    68,040.00 $ 119,070.00 $ 154,791.00 $ 185,749.20 Depreciation expense $        5,000.00 $        7,500.00 $    10,000.00 $    12,500.00 $    15,000.00 $    17,500.00 $    20,000.00 $    22,500.00 EBIT $        8,250.00 $        3,750.00 $       3,500.00 $       3,700.00 $       7,680.00 $    22,190.00 $    31,597.00 $    39,416.40 Interest expense $        2,000.00 $        2,100.00 $       2,310.00 $       2,541.00 $       2,795.10 $       3,074.61 $       3,382.07 $       3,720.28 EBT $        6,250.00 $        1,650.00 $       1,190.00 $       1,159.00 $       4,884.90 $    19,115.39 $    28,214.93 $    35,696.12 Taxes (20%) $        1,250.00 $            330.00 $          238.00 $          231.80 $          976.98 $       3,823.08 $       5,642.99 $       7,139.22 Net income $        5,000.00 $        1,320.00 $          952.00 $          927.20 $       3,907.92 $    15,292.31 $    22,571.94 $    28,556.90 Dividends $                     -   Assets 2014 Cash $      10,000.00 $        5,000.00 $       5,000.00 $       5,000.00 $       5,000.00 $       5,000.00 $       5,000.00 $       5,000.00 Accounts receivable $      30,000.00 $      27,000.00 $    32,400.00 $    38,880.00 $    54,432.00 $    95,256.00 $ 123,832.80 $ 148,599.36 Gross PP&E $      50,000.00 $      75,000.00 $ 100,000.00 $ 125,000.00 $ 150,000.00 $ 175,000.00 $ 200,000.00 $ 225,000.00 Less accumulated depreciation $      10,000.00 $      17,500.00 $    27,500.00 $    40,000.00 $    55,000.00 $    72,500.00 $    92,500.00 $ 115,000.00 Net PP&E $      40,000.00 $      57,500.00 $    72,500.00 $    85,000.00 $    95,000.00 $ 102,500.00 $ 107,500.00 $ 110,000.00 Total assets $      80,000.00 $      89,500.00 $ 109,900.00 $ 128,880.00 $ 154,432.00 $ 202,756.00 $ 236,332.80 $ 263,599.36 Liabilities and Equity Accounts payable $      30,000.00 $      27,000.00 $    32,400.00 $    38,880.00 $    54,432.00 $    95,256.00 $ 123,832.80 $ 148,599.36 Long-term debt $      20,000.00 $      22,000.00 $    24,200.00 $    26,620.00 $    29,282.00 $    32,210.20 $    35,431.22 $    38,974.34 Common stock $      20,000.00 Retained earnings $      10,000.00 $      11,320.00 $    12,272.00 $    13,199.20 $    17,107.12 $    32,399.43 $    54,971.38 $    83,528.27 Total L+E $      80,000.00 $      60,320.00 $    68,872.00 $    78,699.20 $ 100,821.12 $ 159,865.63 $ 214,235.40 $ 271,101.97

Explanation / Answer

Workings

Ans 1 NPV -30,395.62 Ans 2 IRR of the Project 21.90% Ans 3 Since investment does not meet the required return ,should reject the investment.

Workings

Details 2014 2015 2016 2017 2018 2019 2020 2021 Revenue 50,000.00 45,000.00 54,000.00 64,800.00 90,720.00 1,58,760.00 2,06,388.00 2,47,665.60 COGS (Excludes depreciation expense) 36,750.00 33,750.00 40,500.00 48,600.00 68,040.00 1,19,070.00 1,54,791.00 1,85,749.20 Depreciation expense 5,000.00 7,500.00 10,000.00 12,500.00 15,000.00 17,500.00 20,000.00 22,500.00 EBIT 8,250.00 3,750.00 3,500.00 3,700.00 7,680.00 22,190.00 31,597.00 39,416.40 Interest expense 2,000.00 2,100.00 2,310.00 2,541.00 2,795.10 3,074.61 3,382.07 3,720.28 EBT 6,250.00 1,650.00 1,190.00 1,159.00 4,884.90 19,115.39 28,214.93 35,696.12 Taxes (20%) 1,250.00     330.00     238.00     231.80     976.98 3,823.08 5,642.99 7,139.22 Net income 5,000.00 1,320.00 952 927.2 3,907.92 15,292.31 22,571.94 28,556.90 Add Depreciation 7,500.00 10000 12500 15000 17500 20000 22500 Operating Cash flow before WC changes 8,820.00 10,952.00 13,427.20 18,907.92 32,792.31 42,571.94 51,056.90 Net increase in WC                   -                     -                     -                   -                     -                     -                       -   Cash inflow from operations      8,820.00    10,952.00    13,427.20 18,907.92    32,792.31    42,571.94      51,056.90 Less Additional Investment    25,000.00    25,000.00    25,000.00 25,000.00    25,000.00    25,000.00      25,000.00 Less Repayment Of Debt      20,000.00 Funded from Internal Accrual      8,820.00    10,952.00    13,427.20 18,907.92    25,000.00    25,000.00      45,000.00 Equity /Additional Equity(Total Investments) A -30000 -16,180.00 -14,048.00 -11,572.80 -6,092.08                   -                     -                       -   Free Cash flow from Operations (Avialable as Dividend) B                   -                     -                     -                   -        7,792.31    17,571.94        6,056.90 Terminal Cash flow Free Cash flow        6,056.90 Add: Debt Repayment      20,000.00 Free Cash flow for Terminal valuation      26,056.90 Terminal valuation C 2,08,455.20 Net Cash Flow A+B+C -30,000.00 -16,180.00 -14,048.00 -11,572.80 -6,092.08      7,792.31    17,571.94 2,14,512.10 DF @ 40% 1               0.71               0.51               0.36            0.26               0.19               0.13                 0.09 Present Value of cashflows -30,000.00 -11,557.14     -7,167.35     -4,217.49 -1,585.82      1,448.86      2,333.73      20,349.58

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