1. finance

o
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PRINCIPLES OF FINANCE
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CASE IN FINANCE – WORKING COMPUTERS, INC.
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TABLE OF CONTENT
Page
QUESTION 1
3
QUESTION 2
7
QUESTION 3
10
3-A
10
3-B
14
3-C
15
3-D
17
QUESTION 4
18
QUESTION 5
18
QUESTION 6
19
BIBLIOGRAPHY
20
1
CASE STUDY: WORKING COMPUTERS INC.
GIVEN INFORMATION
With
Without
New Investment New Investment
$495
$495
Unit price
Operating expenses (% of retail price)
0.26
0.24
Cost of good sold (% of retail price)
0.54
0.60
Tax rate
0.34
0.34
Overall cost of Capital
0.145
Loan
$18,000,000
Interest rate
0.12
Increase in Account Payable (a)
$3,000,000
Increase in Account Receivable (b)
$5,500,000
Increase in Inventory (c)
$2,000,000
Chang in Net working capital = (b) + (c) - (a)
$4,500,000
Sales Projections (units, in thousands)
2003
With New Investment
2004
2005
2006
2007
2008
2009
180,000 150,000 189,000 246,000 264,000 264,000 264,000
Without New Investment 180,000 150,000 102,000
57,000
48,000
48,000
48,000
Depreciation Table
Ownership
Year
Year
1
2
3
4
5
6
7
1999
2000
2001
2002
2003
2004
2005
Loan depreciated as 5-year asset Depreciation of 10 year-asset Total Annual
$18,000,000
$56,000,000
Recovery
Recovery
Annual Recovery Recovery Annual Recovery Allowance
($)
(%)
Allowance ($)
(%)
Allowance ($)
0.2
0.32
3,600,000
5,760,000
0.1
0.18
0.14
0.12
0.09
0.07
0.07
5,600,000
10,080,000
7,840,000
6,720,000
5,040,000
3,920,000
3,920,000
7,520,000
9,680,000
2
Ownership
Year
Year
8
9
10
11
Loan depreciated as 5-year asset Depreciation of 10 year-asset Total Annual
$18,000,000
$56,000,000
Recovery
Recovery
Annual Recovery Recovery Annual Recovery Allowance
(%)
Allowance ($)
(%)
Allowance ($)
($)
2006
2007
2008
2009
0.19
0.12
0.11
0.06
3,420,000
2,160,000
1,980,000
1,080,000
18,000,000
Total ($)
0.07
0.07
0.06
0.03
3,920,000
3,920,000
3,360,000
1,680,000
56,000,000
7,340,000
6,080,000
5,340,000
2,760,000
QUESTION 1
In order to prepare the cash flow, the items that should be included/excluded as below
No Items
Decision
Reason
a)
Included
The increase in Account receivable, Account
Increase in:
+ Account Payable
Payable and Inventory are the working capital
+ Account Receivable
requirement change, resulted from new investment.
+ Inventory
Therefore, they must be included in investment
cash flow at the beginning of the project. It is in
ofrder to finance operating cycle of the project at
the starting point. This amount of money will be
recovered at the end of the project in 2009
b)
$18 million and interest
Excluded
expenses
c)
d)
Depreciation of both
It already included in WACC of 14.5%, if it is
inlcuded in Cash flow, then it is doublecounted
Excluded
As they are not cash flow but they are used to
$56 million and $18
calculate profit after tax that is a part of net cash
million investment
flow.
Terminal value for
division at the and of
Included
It is cash flow and included in terminal cash flow
which appear only at the end of the project.
2009
Using information given and the above explaination on the four items, the Cash Flow for 2 options
of With New Invetment (Table 1) and Without New Investment (Table 2) will be as following:
3
Table 1: Cash Flow Table for Bernoulli 2004-2009 (With New Investment)
Assumption: $18 million would be invested to Bernoulli division at the end of 2003
No
Items
2003 (Year 0)
2004
2005
2006
2007
2008
2009
74,250,000.00
93,555,000.00
121,770,000.00
130,680,000.00
130,680,000.00
130,680,000.00
1
Initial Investment
2
Working Capital Requirement Change
3
Sales
4
Cost of Goods Sold
(40,095,000.00)
(50,519,700.00) (65,755,800.00)
(70,567,200.00) (70,567,200.00) (70,567,200.00)
5
Operation Expense
(19,305,000.00)
(24,324,300.00) (31,660,200.00)
(33,976,800.00) (33,976,800.00) (33,976,800.00)
6
Less: Depreciation
(7,520,000.00)
(9,680,000.00)
(7,340,000.00)
(6,080,000.00)
(5,340,000.00)
(2,760,000.00)
7
Net Profits before Int. & Taxes
7,330,000.00
9,031,000.00
17,014,000.00
20,056,000.00
20,796,000.00
23,376,000.00
8
Less: Tax
(2,492,200.00)
(3,070,540.00)
(5,784,760.00)
(6,819,040.00)
(7,070,640.00)
(7,947,840.00)
9
Net Profits after Taxes & before Int.
4,837,800.00
5,960,460.00
11,229,240.00
13,236,960.00
13,725,360.00
15,428,160.00
10
Add: Depreciation
7,520,000.00
9,680,000.00
7,340,000.00
6,080,000.00
5,340,000.00
2,760,000.00
11
Working Capital Requirement Recovery
12
Terminal Value
161,213,793.10
13
Tax on Terminal Value
(54,812,689.66)
14
Operating Net Cash Flow
(18,000,000.00)
(4,500,000.00)
4,500,000.00
(22,500,000.00)
12,357,800.00
15,640,460.00
18,569,240.00
19,316,960.00
19,065,360.00
129,089,263.45
Explaination for Table 1:
* Item 2: Working Capital Requirement Change = Increase in Account Receivable + Increase in Inventory - Increase in Accounts Payables
Working capital requirement change is used to finance operating cycle fund at the beginning of the project and would be recovered at the end of the
project when inventory already sold out.
* Item 4: Cost of Good Sold = 54% of Sales
4
* Item 5: Opeation Expenses = 25 of Sales
* Item 6: Refer to Depreciation above
* Item 8: Net profits after taxes & before Int. = (Sales - Cost of Goods sold - Operation Expense – Depreciation) – Corporate Tax
* Item 12: Terminal value = Net Operating Income / Cost of Capital = Net Profit before Increst & taxes / Cost of Capital
Terminal value = 23,376,000.00 / 14.5% = 161,213,793.10
Terminal value in the cash flow must be deducted from tax on Terminal value (34%) and it only appear at the end of the project.
* Item 14:
Operating Net Cash Flow = Net Profit before Int. + Depreciation + Working Capital Requirement Recovery + Terminal value - Tax on Terminal Add
Depreciation is used to calculate Net profits after tax but it is not cash flow run out of the project, based on a Axiom in evaluating project: cash is the king.
Table 2: Cash Flow Table for Bernoulli 2004-2009
Assumption: No investment would be approved to Bernoulli Division
No
Items
1
Initial Investment
2
Sales
3
2003
(Year 0)
0.00
2004
2005
2006
2007
2008
2009
74,250,000.00
50,490,000.00
28,215,000.00
23,760,000.00
23,760,000.00
23,760,000.00
Cost of Goods Sold
(44,550,000.00)
(30,294,000.00)
(16,929,000.00)
(14,256,000.00)
(14,256,000.00)
(14,256,000.00)
4
Operation Expense
(17,820,000.00)
(12,117,600.00)
(6,771,600.00)
(5,702,400.00)
(5,702,400.00)
(5,702,400.00)
5
Less: Depreciation
(3,920,000.00)
(3,920,000.00)
(3,920,000.00)
(3,920,000.00)
(3,360,000.00)
(1,680,000.00)
6
Net Profits before Taxes & Int.
7,960,000.00
4,158,400.00
594,400.00
(118,400.00)
441,600.00
2,121,600.00
7
Tax
(2,706,400.00)
(1,413,856.00)
(202,096.00)
40,256.00
(150,144.00)
(721,344.00)
8
Net Profits after Taxes & before Int.
5,253,600.00
2,744,544.00
392,304.00
(78,144.00)
291,456.00
1,400,256.00
9
Add: Depreciation
3,920,000.00
3,920,000.00
3,920,000.00
3,920,000.00
3,360,000.00
1,680,000.00
5
No
Items
2003
(Year 0)
2004
2005
2006
2007
2008
2009
10
Terminal Value
14,631,724.14
11
Tax on Terminal Value
(4,974,786.21)
12
Operating Net Cash Flow
0.00
9,173,600.00
6,664,544.00
4,312,304.00
3,841,856.00
3,651,456.00
12,737,193.93
Explaination for Table 2:
* Item 3: Cost of Good Sold = 60% of Sales
* Item 4: Opeation Expenses = 24% of Sales
* Item 5: Refer to Depreciation above
* Item 8: Net Profits after Taxes & before Int. = (Sales - Cost of Goods sold - Operation Expense – Depreciation) – Corporate Tax
* Item 12: Terminal value = Net Operating Income / Cost of Capital = Net Profit before Increst & taxes / Cost of Capital
Terminal value = 1,400,256.00 / 14.5% = 14,631,724.14
Terminal value in the cash flow must be deducted from tax on Terminal value (34%) and it only appear at the end of the project.
* Item 12:
Operating Net Cash Flow = Net Profit before Int. + Depreciation + Working Capital Requirement Recovery + Terminal value - Tax on Terminal Add
Depreciation is used to calculate Net profits after tax but it is not cash flow run out of the project, based on a Axiom in evaluating project: cash is the
king.
6
QUESTION 2
Continuing the calculation in Question 1, Table 1: Cash Flow for Bernoulli 2004-2009 (With New Investment), we have Table 3 as below
No
Items
2003 (Year 0)
2004
2005
2006
2007
2008
2009
12,357,800.00
15,640,460.00
18,569,240.00
19,316,960.00
19,065,360.00
129,089,263.45
1
Innitial Investment
(18,000,000.00)
2
Operating Net Cash Flow
(22,500,000.00)
3
Less: After tax Interest Expense
(1,425,600.00)
(1,425,600.00)
(1,425,600.00)
(1,425,600.00)
(1,425,600.00)
(1,425,600.00)
4
After Tax Cash Flow
10,932,200.00
14,214,860.00
17,143,640.00
17,891,360.00
17,639,760.00
127,663,663.45
5
Cumulative Cash Flow
(11,567,800.00)
2,647,060.00
19,790,700.00
(22,500,000.00)
Explaination for Table 3:
* Item 3: Interest expense is the same over 6 years.
Interest Expense = 18,000,000.00 * 12% = $2,160,000 pa
Interest Expense is not counted for Operating Cash Flow but after being deducted from Tax, it is counted for calculation of Payback Period (PB).
After Tax Interest Expenses = 2,160,000 * (1 - 0.34) = $1,425,600.00 pa
* Item 4: After Tax Cash Flow = Operating Net Cash Flow - After Tax Interest Expense
After Tax Cash Flow will be used for calculation of NPV and IRR.
1/ Payback Period (PP)
Payback Period is the exact amount of time required for a firm to recover its initial investment as calculated from Net Cash Inflows (GJF, 2008)
Payback period = [Last year with a neigative NCF] + [Absolute value of NCF in that year / Total cash flow in the following year]
Looking at Table 3 we have:
Payback period = 1 + (11,567,800/14,214,860) = 1.81 years.
7
The Table 3 shows that, the amount received in the year 3 (2006) is 19,790,700 which is greater than the initial investment of $18,000,000. It means
that the maximum acceptable payback period is 3 years. Then, the Payback Period of 1.81 years is less than maximum acceptable period of 3 years, the
project should be accepted.
2/ Net Present Value (NPV)
NPV is a sophisticated capital budgeting technique, found by subtracting a project's initial investment from the present value of its net cash inflows
discounted at a rate equal to the firm's cost of capital (GJF, 2008)
As provided in the case, discount rate = WACC = 14.5%. Continuing calculation from Table 3, we have the below:
Items
Operating Net Cash Flow
2003 (Year 0)
(22,500,000.00)
CF0
NPVWith New Investment
2004
2005
2006
2007
2008
2009
12,357,800.00
15,640,460.00
18,569,240.00
19,316,960.00
19,065,360.00
129,089,263.45
CF1
---------------(1+0.145)1
10,792,838.43
CF2
---------------(1+0.145)2
11,929,947.94
CF3
---------------(1+0.145)3
12,370,227.00
CF4
--------------(1+0.145)4
11,238,719.54
CF5
--------------(1+0.145)5
9,687,630.75
CF6
---------------(1+0.145)6
57,287,148.14
90,806,511.80
Using the same calculation methods for the option of Without New Investment, we have:
Items
2003 (Year 0)
Initial Investment
0.00
Operating Net Cash Flow
0.00
CF0
NPVWithout New Investment
2004
2005
2006
2007
2008
2009
9,173,600.00
6,664,544.00
4,312,304.00
3,841,856.00
3,651,456.00
12,737,193.93
CF1
---------------(1+0.145)1
8,011,877.73
CF2
---------------(1+0.145)2
5,083,460.65
CF3
---------------(1+0.145)3
2,872,717.43
CF4
--------------(1+0.145)4
2,235,214.14
CF5
--------------(1+0.145)5
1,855,404.64
CF6
---------------(1+0.145)6
5,652,503.52
25,711,718.10
8
Results:
* NPVWith New Investment = $90,806,511.80
* NPVWithout New Investment = $25,711,718.10
Thus, NPVWith New Investmnet is greater than 0 and greater than NPVWithout New Investment. As a matter of course, the project should be accepted.
3/ Internal Rate of Return (IRR)
IRR is a sophisticated capital budgeting technique. IRR is the discount rate that equates the present value of net cash inflows with the initial investment
associated with a project, thereby causing NPV =$0 (GJF, 2008).
Using calculator, we have IRRWith New Investment = 77.23% which is greater than the Cost of capital of 14.5%; therefore, the project should be accepted.
Recommendation:
All the calculation results of PP, NPV and IRR are positive which support the acceptance of the project. I would recommend the Working Computers
INc. to go further with investment of $18 million for upgrading Bernoulli Division.
9
QUESTION 3
A. Sensitivity analysis
Option 1: If the Unit Sale down 20% and Cost of Capital = 14.5%, we have below Unit Sales and Cash Flow table for Bernoulli 2004-2009
Unit Sales
2004
120,000
2005
151,200
2006
196,800
2007
211,200
2008
211,200
2009
211,200
Table 5
No Items
2003 (Year 0)
1
Innitial Investment
(18,000,000.00)
2
Working Capital Requirement Change
3
Sales
4
Cost of Goods Sold
(32,076,000.00)
(40,415,760.00) (52,604,640.00)
(56,453,760.00) (56,453,760.00) (56,453,760.00)
5
Operation Expense
(15,444,000.00)
(19,459,440.00) (25,328,160.00)
(27,181,440.00) (27,181,440.00) (27,181,440.00)
6
Less: Depreciation
(7,520,000.00)
(9,680,000.00)
(7,340,000.00)
(6,080,000.00)
(5,340,000.00)
(2,760,000.00)
7
Net Profits before Int. & Taxes
4,360,000.00
5,288,800.00
12,143,200.00
14,828,800.00
15,568,800.00
18,148,800.00
8
Less: Tax
(1,482,400.00)
(1,798,192.00)
(4,128,688.00)
(5,041,792.00)
(5,293,392.00)
(6,170,592.00)
9
Net Profits before Int.
2,877,600.00
3,490,608.00
8,014,512.00
9,787,008.00
10,275,408.00
11,978,208.00
10
Add: Depreciation
7,520,000.00
9,680,000.00
7,340,000.00
6,080,000.00
5,340,000.00
2,760,000.00
11
Working Capital Requirement Recovery
12
Terminal Value
125,164,137.93
13
Tax on Terminal Value
(42,555,806.90)
14
Operating Net Cash Flow
15
Less: After tax Interest Expense
16
After Tax Cash Flow
17
Cumulative cash flow
2004
2005
2006
2007
2008
2009
59,400,000.00
74,844,000.00
97,416,000.00
104,544,000.00
104,544,000.00
104,544,000.00
(4,500,000.00)
4,500,000.00
(22,500,000.00)
10,397,600.00
13,170,608.00
15,354,512.00
15,867,008.00
15,615,408.00
101,846,539.03
(1,425,600.00)
(1,425,600.00)
(1,425,600.00)
(1,425,600.00)
(1,425,600.00)
(1,425,600.00)
8,972,000.00
11,745,008.00
13,928,912.00
14,441,408.00
14,189,808.00
100,420,939.03
(22,500,000.00) (13,528,000.00)
(1,782,992.00)
12,145,920.00
26,587,328.00
10
1/ Payback Period (PP)
Payback period = [Last year with a neigative NCF] + [Absolute value of NCF in that year / Total cash flow in the following year]
Looking at Table 5 we have:
Payback period = 2 + (1,782,992.00 / 13,928,912.00) = 2.13 years.
The Table 3 shows that, the amount received in the year 4 (2007) is 26,587,328.00 which is greater than the initial investment of $18,000,000. It means
that the maximum acceptable payback period is nearly 4 years. Then, the Payback Period of 2.13 years is less than maximum acceptable period of 4
years, the project should be accepted.
2/ Net Present Value (NPV)
With discount rate = WACC = 14.5%, continuing calculation from Table 5, we have the below:
Items
Operating Net Cash Flow
2003
(Year 0)
(22,500,000.00)
CF0
2004
2006
2007
2008
10,397,600.00
13,170,608.00
15,354,512.00
15,867,008.00
15,615,408.00
CF1
---------------(1+0.145)1
CF2
---------------(1+0.145)2
CF3
---------------(1+0.145)3
CF4
--------------(1+0.145)4
CF5
--------------(1+0.145)5
9,231,517.43
7,934,615.80
9,080,873.36
NPV
2005
10,046,038.79
10,228,679.20
2009
101,846,539.03
CF6
---------------(1+0.145)6
45,197,389.88
69,219,114.45
NPVWith New Investment = $69,219,114.45 is greater than 0$ and greater than NPVWithout New Investment = $25,711,718.10, then the project should be accepted.
3/ Internal Rate of Return (IRR)
Using calculator, we have IRRWith New Investment = 66.23% which is greater than the Cost of capital of 14.5%; therefore, the project should be accepted.
11
Option 2: If the Unit Sales keeps the same and Cost of Capital = 14.5% + 3% = 17.5%, the Cash Flow table for Bernoulli 2004-2009 will be as
below:
Table 6
No
Items
2003
(Year 0)
(18,000,000.00)
2004
2005
2006
2007
2008
2009
74,250,000.00
93,555,000.00
121,770,000.00
130,680,000.00
130,680,000.00
130,680,000.00
1
Innitial Investment
2
Working Capital Requirement Change
3
Sales
4
Cost of Goods Sold
(40,095,000.00)
(50,519,700.00) (65,755,800.00)
(70,567,200.00) (70,567,200.00) (70,567,200.00)
5
Operation Expense
(19,305,000.00)
(24,324,300.00) (31,660,200.00)
(33,976,800.00) (33,976,800.00) (33,976,800.00)
6
Less: Depreciation
(7,520,000.00)
(9,680,000.00)
(7,340,000.00)
(6,080,000.00)
(5,340,000.00)
(2,760,000.00)
7
Net Profits before Int. & Taxes
7,330,000.00
9,031,000.00
17,014,000.00
20,056,000.00
20,796,000.00
23,376,000.00
8
Less: Tax
(2,492,200.00)
(3,070,540.00)
(5,784,760.00)
(6,819,040.00)
(7,070,640.00)
(7,947,840.00)
9
Net Profits before Int.
4,837,800.00
5,960,460.00
11,229,240.00
13,236,960.00
13,725,360.00
15,428,160.00
10
Add: Depreciation
7,520,000.00
9,680,000.00
7,340,000.00
6,080,000.00
5,340,000.00
2,760,000.00
11
Working Capital Requirement Recovery
12
Terminal Value
133,577,142.86
13
Tax on Terminal Value
(45,416,228.57)
14
Operating Net Cash Flow
15
(4,500,000.00)
4,500,000.00
(22,500,000.00)
12,357,800.00
15,640,460.00
18,569,240.00
19,316,960.00
19,065,360.00
110,849,074.29
Less: After tax Interest Expense
(1,425,600.00)
(1,425,600.00)
(1,425,600.00)
(1,425,600.00)
(1,425,600.00)
(1,425,600.00)
16
After Tax Cash Flow
10,932,200.00
14,214,860.00
17,143,640.00
17,891,360.00
17,639,760.00
109,423,474.29
17
Cumulative Cash Flow
(22,500,000.00) (11,567,800.00)
2,647,060.00
19,790,700.00
12
1/ Payback Period (PP)
Payback period = [Last year with a neigative NCF] + [Absolute value of NCF in that year / Total cash flow in the following year]
Looking at Table 5 we have: Payback period = 1 + (11,567,800.00 / 14,214,860.00) = 1.85 years.
The Table 6 shows that, the amount received in the year 3 (2006) is 19,790,700.00 which is greater than the initial investment of $18,000,000. It means
that the maximum acceptable payback period is nearly 3 years. Then, the Payback Period of 1.85 years is less than maximum acceptable period of 3
years, the project should be accepted.
2/ Net Present Value (NPV): With discount rate = WACC = 17.5%, continuing calculation from Table 6, we have the below:
Items
Operating
Net Cash Flow
2003
(Year 0)
(22,500,000.00)
CF0
NPV
2004
12,357,800.00
2005
15,640,460.00
2006
18,569,240.00
CF1
---------------(1+0.175) 1
CF2
---------------(1+0.175)2
CF3
---------------(1+0.175)3
10,517,276.60
11,328,535.99
11,446,706.03
2007
2008
19,316,960.00
19,065,360.00
CF4
--------------(1+0.175)4
CF5
--------------(1+0.175) 5
10,134,149.67
8,512,471.62
2009
110,849,074.29
CF6
---------------(1+0.175)6
42,121,601.10
71,560,741.01
NPVWith New Investment = $71,560,741.01 is greater than 0$ and greater than NPVWithout New Investment = $25,711,718.10, then the project should be accepted.
3/ Internal Rate of Return (IRR)
Using calculator, we have IRRWith New Investment = 75.58% which is greater than the Cost of capital of 14.5%; therefore, the project should be accepted.
Conclusion:
Even there are several uncertainties in estimating sales as well as WACC, the Sensitivity analysis above still proves the efficiency of the project.
Therefore, the investment in Bernoulli division is recommended.
13
B. Assumption:
- Discount of 20% on the Unit Price = $396
- Unit Sales keeps the same.
- Cost of Good Sold keeps the same = 54% of Sales
- Operating Expense keeps the same = 26% of Sales
Table 7
No
Name
2003 (Year 0)
2004
2005
2006
2007
2008
2009
59,400,000.00
74,844,000.00
97,416,000.00
104,544,000.00
104,544,000.00
104,544,000.00
1
Innitial Investment
2
Working Capital Requirement Change
3
Sales
4
Cost of Goods Sold
(40,095,000.00)
(50,519,700.00) (65,755,800.00)
(70,567,200.00) (70,567,200.00)
(70,567,200.00)
5
Operation Expense
(19,305,000.00)
(24,324,300.00) (31,660,200.00)
(33,976,800.00) (33,976,800.00)
(33,976,800.00)
6
Less: Depreciation
(7,520,000.00)
(9,680,000.00)
(7,340,000.00)
(6,080,000.00)
(5,340,000.00)
(2,760,000.00)
7
Net Profits before Int. & Taxes
(7,520,000.00)
(9,680,000.00)
(7,340,000.00)
(6,080,000.00)
(5,340,000.00)
(2,760,000.00)
8
Less: Tax
2,556,800.00
3,291,200.00
2,495,600.00
2,067,200.00
1,815,600.00
938,400.00
9
Net Profits before Int.
(4,963,200.00)
(6,388,800.00)
(4,844,400.00)
(4,012,800.00)
(3,524,400.00)
(1,821,600.00)
10
Add: Depreciation
7,520,000.00
9,680,000.00
7,340,000.00
6,080,000.00
5,340,000.00
2,760,000.00
11
Working Capital Requirement Recovery
12
Terminal Value
13
Tax on Terminal Value
(18,000,000.00)
(4,500,000.00)
4,500,000.00
(19,034,482.76)
6,471,724.14
14
No
Name
14
Operating Net Cash Flow
15
Less: After tax Interest Expense
16
After Tax Cash Flow
17
Cumulative Cash Flow
18
Discounted rate
2003 (Year 0)
(22,500,000.00)
NPV
2005
2006
2007
2008
2009
2,556,800.00
3,291,200.00
2,495,600.00
2,067,200.00
1,815,600.00
(7,124,358.62)
(1,425,600.00)
(1,425,600.00)
(1,425,600.00)
(1,425,600.00)
(1,425,600.00)
(1,425,600.00)
1,131,200.00
1,865,600.00
1,070,000.00
641,600.00
390,000.00
(8,549,958.62)
(17,791,600.00) (17,401,600.00)
(25,951,558.62)
(22,500,000.00) (21,368,800.00)
(19,503,200.00) (18,433,200.00)
14.5%
CF0
19
2004
CF1
---------------(1+0.145)1
CF2
---------------(1+0.145)2
CF3
---------------(1+0.145)3
CF4
--------------(1+0.145)4
2,233,013.10
2,510,402.17
1,662,487.99
1,202,708.97
CF5
--------------(1+0.145)5
922,556.01
CF6
---------------(1+0.145)6
(3,161,643.17)
(17,130,474.93)
As shown in Table 7, if the Unit Price is down 20% to $396, providing that all others of Unit Sales, COGS & Operation Expense kept unchanged, the
NPV is neigative. When the project proves inefficiencey, it should be rejected.
C. Calculate the minimum level of annual unit sales for the Bernoulli product before it would be eliminated.
To solve this problem, it is necessary to divide NPV into Fixed NPV and Variable NPV per unit product sold.
Fixed NPV include all cash flows that are independent on number of unit products sold. They include (1) Initial Investment (2) Working Capital
Requirement Change (3) Depreciation (new and current asset) (4) Terminal value. By which, we have the below Fixed Operating Cash Flow:
15
No Name
1
Innitial Investment
2003
2004
2005
2006
2007
2008
2009
(18,000,000.00)
2
Working capital requirement change
3
Sales
0.00
0.00
0.00
0.00
0.00
0.00
4
Cost of goods sold
0.00
0.00
0.00
0.00
0.00
0.00
5
Operation expense
0.00
0.00
0.00
0.00
0.00
0.00
6
Less: Depreciation (new and current asset)
(7,520,000.00) (9,680,000.00) (7,340,000.00) (6,080,000.00)
(5,340,000.00)
(2,760,000.00)
7
Net profits before Int. & taxes
(7,520,000.00) (9,680,000.00) (7,340,000.00) (6,080,000.00)
(5,340,000.00)
(2,760,000.00)
8
Less: Tax
2,067,200.00
1,815,600.00
938,400.00
9
Net profits before Int.
(4,963,200.00) (6,388,800.00) (4,844,400.00) (4,012,800.00)
(3,524,400.00)
(1,821,600.00)
10
Add: Depreciation
5,340,000.00
2,760,000.00
11
Working capital requirement recovery
12
Terminal value
13
Tax on Terminal Value
14
Operating Net Cash Flow
15
Discounted Rate
(4,500,000.00)
2,556,800.00
7,520,000.00
9,680,000.00
2,495,600.00
7,340,000.00
6,080,000.00
4,500,000.00
(19,034,482.76)
6,471,724.14
(22,500,000.00)
2,556,800.00
3,291,200.00
2,495,600.00
2,067,200.00
1,815,600.00
(7,124,358.62)
CF1
---------------(1+0.145)1
CF2
---------------(1+0.145)2
CF3
---------------(1+0.145)3
CF4
--------------(1+0.145)4
CF5
--------------(1+0.145)5
CF6
---------------(1+0.145)6
2,233,013.10
2,510,402.17
1,662,487.99
1,202,708.97
14.5%
CF0
16
3,291,200.00
Fixed NPV
(22,500,000.00)
922,556.01
(3,161,643.17)
(17,130,474.93)
In contrast, the Variable NPV per unit sold include all cash flows that are dependent on number of unit products sold. They include (1) Sale (2) Cost of
good sold (3) Operating Expenses (4) Terminal Value.
16
Cash flow of selling one product can be calculated as below:
No
1
Name
Sales
2
2003
2004
2005
2006
2007
2008
2009
495.00
495.00
495.00
495.00
495.00
495.00
COGS
(267.30)
(267.30)
(267.30)
(267.30)
(267.30)
(267.30)
3
Operating Expenses
(128.70)
(128.70)
(128.70)
(128.70)
(128.70)
(128.70)
4
Operating income
99.00
99.00
99.00
99.00
99.00
99.00
5
Tax on operating income
(33.66)
(33.66)
(33.66)
(33.66)
(33.66)
(33.66)
6
Terminal Value
7
Tax on Terminal value
8
Total
9
Discounted rate
14.5%
10
NPV of selling one product
450.62
682.76
(232.14)
0
65.34
65.34
65.34
65.34
65.34
515.96
Minimum level of annual unit sales before it would be eliminated mean we are planning to sale the number of units at which NPV = 0
In anther words, Fixed NPV + Variable NPV = 0 or (-17,130,475) + 450.62 * Q = 0
Q = 17,130,474.93 / 450.62 = 38,016 units
Conclusion
Minimum level of annual unit sales is 38,016 units
D. The treatment of the Terminal Value as the payment from a perpetuity.
Terminal value in the final forecast year, 2009, should be capitalised using that year's Net Operating Income by dividing them by Overall Cost of
Capital, essentially treating that year's cash flow as the payment from a perpetuity.
Terminal Value = Net Operating Income /Cost of Capital
Terminal Value = (Sales - COGS - Operating Expenses - Depreciation) / cost of capital = $161,213,793.10
17
QUESTION 4
My recommendations are as below:

The calculation results in Question 3 proves the project's efficiency despite of several
uncertainties of unit sales (reduced 20%) and cost of capital (increased 3%). In this case, when
the results of PP, NPV and IRR are all positive, I would recommend the Working Computers
Inc. to accept the new investment of $18 million in the Bernoulli division.

The discount of 20% on the unit price from $495 to $396 makes the NPV is neigative. It means
that the project is not efficient anymore. Therefore, the discount on unit price is unacceptable. In
case, it is needed, the Management should consider the discount rate which must be lower than
20% to make NPV positive or the project efficient.

If the investment in Bernoulli division is accepted, Working Computers may not have money to
invest in other division as suggested by Stewart Workman. The purpose of using this $18
million, by Stewart Workmen, is to boost the ailing performance of other parts of the firm.
Therefore, in order to efficiently use the money, the Company should have analysis for the
investment that suggested by Stewart to make comparision to the project of Bernoulli. The final
decision on the use of fund should be based on the analysis results.
QUESTION 5
The Price of Selling Bernoulli division should be the Present Value of the future expected Cash
Flows generated from the Project.
Option 1: Selling price with investment requested
Items
2004
2005
2006
2007
2008
2009
12,357,800.00
15,640,460.00
18,569,240.00
19,316,960.00
19,065,360.00
129,089,263.45
CF5
--------------(1+0.145)5
CF6
---------------(1+0.145)6
Operating
Net Cash
Flow
Discounted
Rate
PV
14.5%
CF1
---------------(1+0.145)1
CF2
---------------(1+0.145) 2
10,792,838.43
11,929,947.94
CF3
---------------(1+0.145)3
CF4
--------------(1+0.145)4
12,370,227.00 11,238,719.54
9,687,630.75 57,287,148.14
113,306,511.80
Bernoulli division should be sold, after making the requested investment, at price of
$113,306,511.80
18
Option 2: Selling price without investment requested
Items
Operating Net Cash
Flow
Discounted Rate
2004
2005
2006
2007
9,173,600.00 6,664,544.00 4,312,304.00 3,841,856.00
2009
3,651,456.00 12,737,193.93
14.5%
CF1
---------------(1+0.145)1
CF2
---------------(1+0.145) 2
CF3
---------------(1+0.145) 3
CF4
--------------(1+0.145) 4
8,011,877.73 5,083,460.65 2,872,717.43 2,235,214.14
PV
2008
CF5
--------------(1+0.145)5
CF6
---------------(1+0.145)6
1,855,404.64
5,652,503.52
25,711,718.11
In case of no investment to Bernoulli division, it should be sold at price of $25,711,718.11
QUESTION 6
It is essential to overlook the total benefit and cost expected to be brought. To calculate the real
impact when making decisions, to analyze the benefits and costs of projects incremental
assumption. When the benefit could be high enough to cover its cost, the decision making is turn on
the option that can bring more benefit. Must be set and answered questions about the cash flow in
case the project is done and vice versa.
Besides, when a firm is considering the elimination of a product line or selling a division, it should
not only consider the financial factors/profits as mentioned all above but also non-financial factors.
For a big firm, the elimination of product line or selling a division may cause affect on its
reputation. This can be seen as a bad signal on its financial ability, technology, capacity, etc. This
decision of the company can be translated into many different things by competitors and also
customers. Always, the competiors try to find your weak points for fighting. Then, if the selling of a
division should be carefully considered, if not, it will cause bad troubles to the company. The lose
of reputation may cause also bad affects on other products.
So, the elimination of product line or selling a division should be carefully considered, if not, the
profit gained from the selling is not enough to cover the potential loses./.
19
BIBLIOGRAPHY
Gitman/Juchau/Flanagan, 2008. Principles of Managerial Finance, 5th edition. Pearson
Education Australia.
20