Expansion Project Example Dr C Bulent Aybar Professor
Expansion Project Example Dr. C. Bulent Aybar Professor of International Finance
• The Gomez Co. is considering an investment project. Gomez has sufficient excess capacity in its plant to take on the project by making an investment in additional new equipment. • The investment in land is $2 million; in plant is $8 million, subject to MACRS depreciation at 3 percent per year. The equipment cost is $10 million, and it qualifies in the five-year asset class under MACRS depreciation. • The investment is expected to be completed at the end of 2014, and first project cash flows are expected to be generated at the end of 2015. • The project life is six years over the years 2015 through 2020. • Expected sales and unit sales price are given as follows: © Dr. C. Bulent Aybar
Case Data Investment Outlay Land 2, 000 Plant 8, 000 Equipment 10, 000 NWC Investment 800, 000 Sales Volume 2015 2016 2017 2018 2019 2020 Sales Price (Real Units USD) 10, 000. 00 1, 000 14, 000. 00 1, 000 20, 000. 00 1, 000 25, 000. 00 1, 000 28, 000. 00 1, 000 30, 000. 00 1, 000
• The sales price per unit in 2015 real dollars will be $1, 000 for each of the years. Cash operating costs are projected at 75% of sales. • The applicable tax rate for Gomez is 34%. • The project will require an initial working capital investment of $800, 000 in 2014 and during the operational period net working capital will be 10% of sales. • For instance, if Gomez’s expected sales in 2015 is $10, 000, working capital requirement will be $1, 000 and company will have to invest $200, 000 in its net working capital to support its operations. Thereafter the incremental investment in in net working capital each year will be 10% of the sales increase. • The total networking capital investment will be recovered at the end of the sixth year. © Dr. C. Bulent Aybar
• Although no salvage value is taken into account in calculating MACRS depreciation , Gomez forecasts that the equipment will have a salvage value of $1 million at the end of 2020. Column 1 Salvage values 2020 (2014 real dollars) Land Building Equipment Total Salvage Value $2, 000 $6, 680, 000 $1, 000 2, 000 8, 000 10, 000 2, 000 6, 680, 000 0 Gain/Loss 0 0 1, 000 Tax Liability/Credit 0 0 340, 000 Net salvage values 2, 000 6, 680, 000 660, 000 Initial cost Depreciable basis 2014 Book value, 2020 9, 340, 000. 00 © Dr. C. Bulent Aybar
Project Cash Flows Investment Outlay Property, Plant & Equipment NWC Total Outlay Unit Sales Price Real Inflation Sales Price Nominal Net Sales Cash Operating Costs EBITDA Depreciation on Equipment Depreciation on Building Income Before Taxes Tax (@34%) Income After Tax Depreciation Change in NWCI Cumulative NWCI Net Salvage Values Total Cash Flows 2014 0 (20, 000) (800, 000) (20, 800, 000) 2015 1 10, 000 1, 000 0% 1, 000 10, 000 7, 500, 000 2, 000 240, 000 260, 000 88, 400 171, 600 2, 240, 000 (200, 000) (1, 000) 2, 211, 600 2016 2 2017 3 2018 4 2019 5 2020 6 14, 000 1, 000 20, 000 1, 000 25, 000 1, 000 28, 000 1, 000 30, 000 1, 000 14, 000 10, 500, 000 3, 200, 000 240, 000 60, 000 20, 400 39, 600 3, 440, 000 (400, 000) (1, 400, 000) 3, 079, 600 1, 000 20, 000 15, 000, 000 1, 900, 000 240, 000 2, 860, 000 972, 400 1, 887, 600 2, 140, 000 (600, 000) (2, 000) 3, 427, 600 1, 000 25, 000 18, 750, 000 6, 250, 000 1, 200, 000 240, 000 4, 810, 000 1, 635, 400 3, 174, 600 1, 440, 000 (500, 000) (2, 500, 000) 4, 114, 600 1, 000 28, 000 21, 000 7, 000 1, 100, 000 240, 000 5, 660, 000 1, 924, 400 3, 735, 600 1, 340, 000 (300, 000) (2, 800, 000) 4, 775, 600 1, 000 30, 000 22, 500, 000 7, 500, 000 600, 000 240, 000 6, 660, 000 2, 264, 400 4, 395, 600 840, 000 (200, 000) (3, 000) 9, 340, 000 17, 375, 600
Project Evaluation: NPV and IRR Real Cost of Capital Inflation Nominal Cost of Capital NPV IRR 7% 0 0. 07 4, 876, 741. 78 12. 24%
Project Cash Flows under 5% Inflation Assumption Investment Outlay Property, Plant & Equipment NWC Total Outlay Unit Sales Price Real Inflation Sales Price Nominal Net Sales Cash Operating Costs EBDIT Depreciation on Equipment Depreciation on Building Income Before Taxes Tax (@34%) Income After Tax Depreciation Change in NWCI Cumulative NWCI Net Salvage Values Total Cash Flows Real Cost of Capital Inflation Nominal Cost of Capital NPV IRR 2014 0 2015 1 2016 2 2017 3 2018 4 2019 5 2020 6 10, 000 1, 000 5. 00% 1, 000 10, 000 7, 500, 000 2, 000 240, 000 260, 000 88, 400 171, 600 2, 240, 000 14, 000 1, 000 5. 00% 1, 050 14, 700, 000 11, 025, 000 3, 675, 000 3, 200, 000 240, 000 235, 000 79, 900 155, 100 3, 440, 000 20, 000 1, 000 5. 00% 1, 103 22, 050, 000 16, 537, 500 5, 512, 500 1, 900, 000 240, 000 3, 372, 500 1, 146, 650 2, 225, 850 2, 140, 000 25, 000 1, 000 5. 00% 1, 158 28, 940, 625 21, 705, 469 7, 235, 156 1, 200, 000 240, 000 5, 795, 156 1, 970, 353 3, 824, 803 1, 440, 000 28, 000 1, 000 5. 00% 1, 216 34, 034, 175 25, 525, 631 8, 508, 544 1, 100, 000 240, 000 7, 168, 544 2, 437, 305 4, 731, 239 1, 340, 000 30, 000 1, 000 5. 00% 1, 276 38, 288, 447 28, 716, 335 9, 572, 112 600, 000 240, 000 8, 732, 112 2, 968, 918 5, 763, 194 840, 000 (200, 000) (1, 000) 2, 211, 600 (470, 000) (1, 470, 000) 3, 125, 100 (735, 000) (2, 205, 000) 3, 630, 850 (689, 063) (2, 894, 063) 4, 575, 741 (509, 355) (3, 403, 418) 5, 561, 884 (425, 427) (3, 828, 845) 11, 512, 803 21, 519, 414 (20, 000) (800, 000) (20, 800, 000) 7% 5% 12. 35% 2, 883, 803. 49 15. 70%
Salvage Values with Inflation Column 1 Initial Investment Salvage Value Book Value in 2020 Capital Gain/Loss at Liquidation Taxes Net Salvage Value Land Building Equipment Total Salvage Value 2, 000 8, 000 10, 000 2, 680, 191 8, 951, 839 1, 340, 096 2, 000 6, 680, 000 680, 191 2, 271, 839 1, 340, 096 231, 265 772, 425 455, 633 2, 448, 926 8, 179, 414 884, 463 11, 512, 803
Project NPV and IRR Real Cost of Capital Inflation Nominal Cost of Capital NPV IRR 7% 5% 12. 35% 2, 883, 803. 49 15. 70%
- Slides: 10