# Problem: Calculate on the diff

Problem: Calculate on the difference between FCF Do –FCF Don’t Do

Prepare a template of doing the project and then a secondtemplate of not doing the project

Assumptions change

If you don’t do the project you will sell the land in Y0

Compare the two and calculate incremental NPV

Sunk costs

Ignore, not incremental

\$50 spent two years ago, we are not getting back

Given Information:

2 year project

Capital required for P&E = \$2500 in Y0

WC = \$550 in Y1 and \$600 in Y2. Total not incremental WC &required at beginning of the year

Salvage value of P&E at end of 2 years = \$900

Depreciation in each of first 2 years = \$1,000

Production is 1,000 units per year.

Assume revenue & costs are all incurred at the end of eachyear

Price = \$2 / unit in Y1 and increases at a rate of 20%

Operating costs in Y1 = \$400, Y2 = \$500

Company owns land on which to build a plant which has a bookvalue of \$300.   The current market value is \$300 but itis expected to rise at an annual rate of 5%. The land will be soldafter 2 years.

Company originally planned to start the project 2 years ago andspent \$50 in planning, but shelved it.

Tax rate = 34%

Cost of capital = 15%

Tax on asset sale

Profit / loss = Sale Proceeds – Book value

Book value = Purchase price – accumulated depreciation

Suppose you bought equipment for \$2,500, depreciated it for twoyears at \$1,000 per year and sell it for \$900 at the end of thesecond year

Purchase price = \$2,500

Accumulated depreciation = \$2,000

Book value = \$2,500 – 2,000 = \$500

Taxable profit in Y2 = \$900 – 500 = \$400

____________________________________________

Include in the template:

Working Capital

Year 0,1,2

Revenue

Cash Cost

Depreciation of Equiptment

Profit/loss from asset sale

Equipment

Land

Taxable operating income

Tax on Operating income

Net oper profit after tax (NOPAT)

Depreciation of Equipment

Profit/Loss from asset sale

Equipment

Land

Operating Cash Flow

Changes In Working Capital

Capital Expenditure

Equipmeent

Land

Free Cash Flow to all capital

 Year Revenue Operating costs Working Capital Depriciation Profit Before Tax Tax(@34%) Profit After Tax Depreciation Cash Flow PV Factor(@15%) PV of Cash Flow 1 2000 (400) (550) (1000) 50 (17) 33 1000 1033 0.870 898.71 2 2400 (500) (50) (1000) 850 (289+136)=(425) 425 1000 1425+900=2325 0.756 1757.7 TOTAL 2656.41

Year 1 revenue = 1000*2 = \$2000

Year 1 revenue = 1000*(2.4) = \$2400 (20% increase in price)

Tax on profit on sale of P&E = 900(sale) – 500(BookValue)=400(profit)*(0.34)=\$136

Working Capital is total, therefore , for year 2, WC=600-550=\$50

\$900 salvage value is added to the cash flow.

\$300 value of land is an asset and it is not adeterminant for the taking up of the project as the company alreadyowns the land and has not bought it for the purpose of theproject.

The \$50 spent 2 years back would have been taken intoaccount (P&L account) because it has already beenshelved.

The initial investment is \$2500

PV of future cash flows from the project =\$2656.41

Therefore, NPV of the project is \$156.41.

The incremental cash flow in year 1 is \$1033(PV=\$898.71) and in year 2 it is \$2325(PV=\$1757.7)

If we don’t do the project then we would get \$300 inyear 0.

If we do it then,

 Year Value PV Factor @ 15% PV 1 300*(1.05)=315 0.870 274.05 2 315*(1.05)=330.75 0.756 250.047

The land will be sold at \$330.75 after 2 years, which at year 0has a value of \$250.047. Adding to this the NPV of the projectundertaken,i.e, \$156.41. Total equals\$406.457.

It is better to take up the project than selling off the landbecause if the project is taken there would be a benfit of\$106.457(406.457-300).

Note: Brackets indicate negative number orsubtraction.

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