Net income + cash flow and NPV for a company

User Generated

NOR18

Business Finance

Description

1. Wind Power Inc. (WPI) builds and operates wind farms that generate electric power suing windmills. The firm has wind farms throughout the Southwest. In December 2017, the owner of WPI, Steve Simonson, decided to invest $100,000 in a new production monitoring system. Steve is an engineer by profession, but he is fully aware of the difference between the accounting profit and economic profit. As a result he would like to utilize the Economic Value Added (EVA) concept to determine whether to invest in this new piece of equipment? He has hired you to assist him in determining the present value of EVA. His accountant has provided the following information pertaining to income statement. The projected sales revenue information is contained in the attached Excel file (FIN630_Final Exam Version_2018.xlsx):

a. Cost of goods sold is 40% of revenue; Operating expense is 20% of revenue; Depreciation is straight line to zero salvage value over a 5-year life; Interest expense is $1,600 per year for the next 5 years; and Tax rate is 30%.

b. WPI’s book value capital structure is as follows: 75.0% equity and 25% debt. WPI’s before tax cost of debt is 6.4% and has a beta of 1.8. The risk free rate of interest is 3% and the market risk premium (Rm-Rf) is 6%. Based on the information provided above, you are asked to do the following:

1- Complete the income statements for 2018-2022. Examine the trend in net income (NI). What is your assessment of financial suitability of this project? Although Steve is not a fan of selecting projects based solely on accounting profitability, he is, however, willing to hear your assessment of this project. What will you present to Steve?

2- Calculate the Weighted Average Cost of Capital (WACC) for WPI. Place your answer is cell C4.

3- Calculate the Free Cash Flow to Firm (FCFF) for years 2017-2022. Place your answer in cells C30-H30. As stated above, 2017 cash outflow is exclusively based on initial capital investment and no additional capital was invested thereafter. The annual changes in net working capital are given in the spreadsheet.

4- Find the Net Present Value (NPV) of this project based on FCFF. Place your answer in cell C33. What is your recommendation? Is the NPV based recommendation different from what you stated in response to question (i)? Explain.

5- Calculate EVA for the years 2018-2022. Find the present value of all future EVAs and place the answer in cell C43. Does the project add economic value? What is your overall recommendation regarding this project. Should WPI accept this project? Explain.

Unformatted Attachment Preview

Given Tax Rate Capital Expenditures in 2017 WACC 30.00% ($100,000) and none thereafter Project Pro Forma Income Statements 2018 Revenues Less: Cost of Goods Sold Gross Profit Less: Operating Expenses Less: Depreciation Expense Net Operating Income Before Taxes Less: Interest Expense Earnings before Taxes Less: Taxes Net Income $ Year 2020 2019 100,000.00 $ 105,000.00 $ 2021 110,250.00 $ 2022 115,762.50 $ 121,550.63 Project Free Cash Flows Year 2017 Net Operating Income Before Taxes Less: Taxes NOPAT Plus: Depreciation Less: CAPEX Less: Change in NWC Project Free Cash Flow to Firm 2018 $ $ 2019 - (100,000.00) (5,000.00) (105,000.00) $ 2020 - (250.00) $ 2021 - (262.50) $ 2022 - (275.63) $ - (289.41) 6,077.53 What is the project's expected NPV? NPV Economic Value Added from 2018-2022 2018 Invested Capital NOPAT Less: Capital Charge EVA PV of EVAs $ 105,000.00 $ 2019 85,250.00 $ Year 2020 65,513.00 $ 2021 45,788.00 $ 2022 26,078.00
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Explanation & Answer

Attached.

Given
Tax Rate
Capital Expenditures in 2017
WACC

30.00%
($100,000)
9.72%
Project Pro Forma Income Statements
2018

Revenues
Less: Cost of Goods Sold
Gross Profit
Less: Operating Expenses
Less: Depreciation Expense
Net Operating Income Before Taxes
Less: Interest Expense
Earnings before Taxes
Less: Taxes
Net Income

$
$

$
$
$

Year
2020

2019

100,000.00
40,000.00
60,000.00
20,000.00
20,000.00
20,000.00
1,600.00
18,400.00
5,520.00
12,880.00

$
$

$
$
$

105,000.00
42,000.00
63,000.00
21,000.00
20,000.00
22,000.00
1,600.00
20,400.00
6,120.00
14,280.00

$
$

$
$
$

110,250.00
44,100.00
66,150.00
22,050.00
20,000.00
24,100.00
1,600.00
22,500.00
6,750.00
15,750.00
...


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