Project Net Present Value and Volatility using Simulation.

Year 1 sales is uniformly distributed betw

$2000 and $4000. Thereafter, sales are forecasted to grow exponentially at a rate that is normally distri
with a mean 4 percent and a standard deviation of 2 percent a year. Incremental variable costs are expe
to be 50 percent of incremental revenues. Incremental working capital required in each year is expected
$900 in year 0. Thereafter, net working capital is expected to be 30 percent of incremental revenues in t
following year. Incremental fixed cash cost are expected to be $60 in year 1 and growing by $5 each ye
thereafter. This three-year project requires an immediate investment of $600 in plant and equipment. Pl
and equipment are to be depreciated over 6 years on a straight-line basis to zero value. At the end of
project the equipment can be sold for $100. The tax rate is 40% and the required return is 10%.

Calculate the Net Present Value (NPV) of the project at a wacc of 10%.
Calculate the project volatility.

Copyright by Domingo Castelo Joaquin 2005, dcjoaqu@ilstu.edu

Year 0 Year 1

Sales growth rate

Variable Costs as % of Sales 50%

Sales 3,000
Variable Cost 1,500
Fixed Cash cost 60
Depreciation 100
Earnings Before Interest and Taxes 1,340
Tax 536
Net Operating Profit After Taxes 804
Depreciation 100
Investment in Net Working Capital 900 37
Investment in Fixed Assets 600
Free Cash Flow (CF) (1,500) 867

Present Value of Remaining CFs, PV(CFs) $3,131 $ 2,576

LN(PV1+CF1) 8.14

Cost of Capital 10.00%

Net Present Value $1,631

Projected Net Working Capital Level 900 937

Investment in Net Working Capital 900 37
Historical Cost of Fixed Assets 600 600
Accumulated Depreciation 100
Ending Book Value 600 500

Salvage Value
Ending Book Value
Capital Gains
Capital Gains Tax

Salvage Value
Captial Gains Tax
Net Proceeds from Sale of Fixed Assets

Year 0 Year 1

Notation:

PV = Present value of remaining cash flows as of the end of year 0.

NPV = Net present value.

PV1 = Present value of remaining cash flows as of the end of year 1.

CF1 = Free cash flow in year 1.

LN(PV1+CF1) = Natural logarithm of (PV1+CF1).

1 sales is uniformly distributed between
tially at a rate that is normally distributed
Incremental variable costs are expected
al required in each year is expected to be
percent of incremental revenues in the
n year 1 and growing by $5 each year
of $600 in plant and equipment. Plant
e basis to zero value. At the end of the
the required return is 10%.

of 10%.

Year 2 Year 3

4% 4%
50% 50%

3,122 3,250
1,561 1,625
65 70
100 100
1,396 1,455
558 582
838 873
100 100
38 (975)
(180)
900 2,128

975 -
38 (975)
 600 600
200 300
400 300

100
300
(200)
(80)

100
-80
180

Year 2 Year 3
 Project Net Present Value and Volatility using Simulation. Year 1 sales is uniformly distributed betw
$2000 and $4000. Thereafter, sales are forecasted to grow exponentially at a rate that is normally distri
with a mean 4 percent and a standard deviation of 2 percent a year. Incremental variable costs are expe
to be 50 percent of incremental revenues. Incremental working capital required in each year is expected
$900 in year 0. Thereafter, net working capital is expected to be 30 percent of incremental revenues in t
following year. Incremental fixed cash cost are expected to be $60 in year 1 and growing by $5 each ye
thereafter. This three-year project requires an immediate investment of $600 in plant and equipment. Pl
and equipment are to be depreciated over 6 years on a straight-line basis to zero value. At the end of
project the equipment can be sold for $100. The tax rate is 40% and the required return is 10%.

Calculate the Net Present Value (NPV) of the project at a wacc of 10%.
Calculate the project volatility.

Copyright by Domingo Castelo Joaquin 2005, dcjoaqu@ilstu.edu

Year 0 Year 1

Sales growth rate

Variable Costs as % of Sales 50%

Sales #ADDIN?
Variable Cost #ADDIN?
Fixed Cash cost 60
Depreciation 100
Earnings Before Interest and Taxes #ADDIN?
Tax #ADDIN?
Net Operating Profit After Taxes #ADDIN?
Depreciation 100
Investment in Net Working Capital 900 #ADDIN?
Investment in Fixed Assets 600
Free Cash Flow (CF) (1,500) #ADDIN?

Present Value of Remaining CFs, PV(CFs) #ADDIN? #ADDIN?

LN(PV1+CF1) #ADDIN?

Cost of Capital 10.00%

Net Present Value #ADDIN?

Projected Net Working Capital Level 900 #ADDIN?

Investment in Net Working Capital 900 #ADDIN?
Historical Cost of Fixed Assets 600 600
Accumulated Depreciation 100
Ending Book Value 600 500

Salvage Value
Ending Book Value
Capital Gains
Capital Gains Tax

Salvage Value
Captial Gains Tax
Net Proceeds from Sale of Fixed Assets

Year 0 Year 1

Notation:

PV = Present value of remaining cash flows as of the end of year 0.

NPV = Net present value.

PV1 = Present value of remaining cash flows as of the end of year 1.

CF1 = Free cash flow in year 1.

LN(PV1+CF1) = Natural logarithm of (PV1+CF1).

1 sales is uniformly distributed between
tially at a rate that is normally distributed
Incremental variable costs are expected
al required in each year is expected to be
percent of incremental revenues in the
n year 1 and growing by $5 each year
of $600 in plant and equipment. Plant
e basis to zero value. At the end of the
the required return is 10%.

of 10%.

Year 2 Year 3

#ADDIN? #ADDIN?
50% 50%

#ADDIN? #ADDIN?
#ADDIN? #ADDIN?
65 70
100 100
#ADDIN? #ADDIN?
#ADDIN? #ADDIN?
#ADDIN? #ADDIN?
100 100
#ADDIN? #ADDIN?
(180)
#ADDIN? #ADDIN?

#ADDIN? -
#ADDIN? #ADDIN?
 600 600
200 300
400 300

100
300
(200)
(80)

100
-80
180

Year 2 Year 3