Problem: You have a business idea and wish to determine whether or not it is wor

Question

Problem:

You have a business idea and wish to determine whether or not it is worth starting a new firm for this project the new firm will not have any other projects. You have made estimates and forecasts as follows. For the first year you use quarterly estimates to better reflect the start-up phase; for years 2 to 5 you use annual estimates. For simplicity reasons, assume that depreciation and taxes are determined on a quarterly basis for the first year and annually after that. · At time zero you need to buy equipment for 7,500; which depreciates straight-line at a rate of 4% quarterly, and you deposit 850 in cash which you plan to keep constant over time. At time zero you also invest 2,500 in inventory. Sales: Zero in the first quarter, 650 in the second quarter, expected to grow 50% in the third quarter and to grow 35% in the fourth quarter. Sales are expected to be 3,200 in year 2 and to grow 6% per year until year 5. · COGS have a ratio over sales of 0.30 in year 1, and 0.25 in years 2 to 5. SG&A expenses are constant over time at 250 in each quarter, starting in the first quarter. .In addition, you run a marketing campaign (mainly online advertising) starting at time zero and continuing throughout year 1 with quarterly expenses of 300. Inventory will be 3,000 at the end of each quarter. Accounts receivable are expected to be 20% of sales at the end of each quarter. Accounts payable are expected to be 15% of COGS and SG&A at the end of each quarter. Your opportunity cost of capital is 15% annually. The corporate tax rate is 25%; tax loss carry forward is allkww Assume that your firm lives forever, after year 5, FCF growth is expected to be 2% per year, forever. . . · .

Explanation / Answer

Soln : a) Please refer here the table, we have calculated the FCF using the formula = PAT + depreciation - change in WC - change in capital expenditure

Change in WC = change in receivables +change in inventories - change in accounts payable

Capital expenditure change = 0

b) We now have condition that FCF will grow by 2% per year forever, we can say that terminal value at year 5 = FCF at year 5/0.02 = 1734/0.02 = 86695(approx.)

discount rate given = cost of capital = 15% annually

NPV calculated here in the table

We can see here NPV of the firm = 42619.62, we have calculated the initial investment = 850+2500 = 3350

Year 0 0.25 0.5 0.75 1 2 3 4 5 Initial investment 7500.00 Cash 850.00 WC investment 2500.00 Revenue 0.00 650.00 975.00 1316.25 3200.00 3392.00 3595.52 3811.25 COGS 0.00 195.00 292.50 394.88 800.00 848.00 898.88 952.81 SG &A 250.00 250.00 250.00 250.00 1000.00 1000.00 1000.00 1000.00 Marketing Campaign 300.00 300.00 300.00 300.00 PBDIT -550.00 -95.00 132.50 371.38 1400.00 1544.00 1696.64 1858.44 Depreciation 300.00 300.00 300.00 300.00 1200.00 1200.00 1200.00 1200.00 PBT -850.00 -395.00 -167.50 71.38 200.00 344.00 496.64 658.44 Taxes 0.00 0.00 0.00 0.00 0.00 0.00 0.00 89.49 PAT -850.00 -395.00 -167.50 71.38 200.00 344.00 496.64 568.95 Accounts receivable 0.00 130.00 195.00 263.25 640.00 678.40 719.10 762.25 Accounts Payable 37.50 66.75 81.38 96.73 270.00 277.20 284.83 292.92 Change in accounts receivable 130.00 65.00 68.25 376.75 38.40 40.70 43.15 Change in accounts payable 0 29.25 14.63 15.36 173.27 7.20 7.63 8.09 bInventory 3000.00 3000.00 3000.00 3000.00 3000.00 3000.00 3000.00 3000.00 Change 500.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Free Cash flow -1050 -196 82 318 1197 1513 1664 1734

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