You are a major grocery chain (Fine Foods R Us) and are now contemplating starti
ID: 2782155 • Letter: Y
Question
You are a major grocery chain (Fine Foods R Us) and are now contemplating starting a food truck supply service. You will prepare (pre-cook and then freeze or chill) 'small plates' - like Tapas, which will then be sold to owners of food trucks. The start-up cost is $120 million. Your financial analysts calculate that the operation will produce free cash flow (FCFF) of $7million the 1t year, and that this free cash flow will grow by 10% over the following 25 years (i.e., g-10% for t through t-26). After that, free cash flow is expected to grow at a constant rate of 4% forever Your WACC for this project is 8%, what is the project's NPV? USE TVM FORMULAS!Explanation / Answer
Amount in $ Millions The NPV of the project is the PV of the expected FCFs less the start up cost of $120 million. The PV of the FCF is to be found out in three stages as below: 1) PV of the FCF for the 1st year = 7/1.08 = $ 6.48 2) PV of the FCF for the 25 years--2nd year to 26th year. It is a growing annuity, whose discounted value as at t=1 is given by the formula: PVGA = [C1/(r-g)]*[1-((1+g)/(1+r))^n] Where PVGA = PV of the growing annuity C1 = the first payment r = interest rate per period g = a constant growth rate per period n= number of periods Substituting values in the above equation , we have PVGA = ((7*1.1)/(0.08-0.10))*((1-(1.1/1.08)^25)) = $ 224.09 The above value is at t1. To bring it to t0, it has to be discounted for 1 year at 8% = 224.09/1.08 = $ 207.49 3) Terminal value of the FCF that grows at the constant rate of 4% from the 27th year = FCF27/(r-g) = 7*1.1^25*1.04/(0.08-0.04) = $ 1,971.92 The above value is at t26, which has to be discounted to t0 = 1971.92/1.08^26 = $ 266.61 4) Total PV of the expected FCF = 6.48+197.24+266.61 = $ 480.58 Less: Start up cost $ 120.00 NPV $ 360.58 Answer
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.