Corporate Finance

Corporate Finance
Exercises session #2
Block 7 (Capital Budgeting: NPV)
October 26th, 2018
Corporate Finance: Lectures and Seminars, HEC Liège (ULiège) 2018-2019 – Marie Lambert 1
Cash flows
An American multinational technology company investigates
the launch of a new cell phone next year, the « M2 ».
The M2 is planned to be sold in addition to the « M1 » current
model, that will only be discontinued 3 years from now (end-
of-year). If the M2 is launch, part of the M1’s revenue would
be cannibalized (i.e. by 20% each year) until the phone is
discontinued.
One of the new features of the M2 is its increased connectivity
with the company’s famous ultrabook (the Qbook). As such,
the company expects its Qbook’s revenue to increase by 10%
each year if the M2 is launched.
Cash flows
If the company does not launch the M2 phone next year but wait for M1’s
discontinuation in 3 years, M1 and Qbook revenue would be as follows (in
$billions) during the next 3 years:
Year 1 Year 2 Year 3
M1 20 25 30
Qbook 5 8 10
If the company decides to launch the M2 phone next year, M2’s direct
revenue would be as follows (in $billions) during the next 3 years:
Year 1 Year 2 Year 3
M2 30 45 55
In valuing M2’s project, which incremental revenue should the company’s

analysts account for during the next 3 years?
Finite life analysis - Q1
Consider the following expected FCFFs for an investment project
that will start one year from now (in $millions):
Year 1 2 3 4
FCFF 100 150 180 200
The cost of the project is $479.98 million. You know that the WACC
of the company is 10.58% and that this project is more risky than
the current assets of the company.
a) Should you invest in this project? Why?
b) If the project was less risky than the company’s current assets,
would your answer to point a) be different?
Finite life analysis – Q2
As an analyst for a company, you consider to build offices to
rent on a piece of land already owned by the company:
– The land is currently evaluated at $200,000 (but was acquired a
few years ago for $150,000); Don't use $150,000 but use $200,000
– The cost of the building is also estimated at $200,000;
– A feasibility study was ordered to a consulting firm and you have
just paid $20,000 for the results; $20,000 = sunk cost
– The building will be depreciated straight-line over 10 years;
– Renting activity is expected to provide FCFFs of $50,000 in year 1,
$60,000 in year 2, $70,000 in year 3, and $80,000 in year 4;
– At the end of year 4, the building will be sold at salvage value.
What is the NPV of the offices renting project if the required
rate of return is 10%?
Tax shields
Your firm intends to launch next year a new project in the
production department. You have just completed the estimation of
the project's Net Present Value (NPV) when the production
manager informs you that the initial fixed investment will finally
cost an additional $50,000. This investment is depreciated straight-
line over a four-year life. The tax rate is 25% and the required rate
of return is 15%. No changes in cash operating revenue, cash
operating expenses, or salvage value are expected.
What is the effect on the project's NPV?
Infinite life analysis – Q1
BeerCo, a Belgian beverage company, plans to diversify its activities
and develop a frozen food division. As a financial analyst of BeerCo,
you estimate the new project will generate the following
incremental FCFFs (in $millions) during 5 years (after 5 years, the
project will reach maturity and grow at a steady rate of 2%):
Year 1 2 3 4 5
FCFF 100 180 250 300 350
You have also collected information about BeerCo’s current peers
(i.e. in the beverage industry) and expected peers in the frozen food
industry: Just use the right table bcs the new project is frozen food
division
Beverage Beta D/E Tax rate Frozen Beta D/E Tax rate
Peer 1 0.80 1.2 30% Peer 1 0.60 0.70 30%
Peer 2 0.65 0.8 30% Peer 2 0.70 0.80 30%
Peer 3 0.75 1.0 30% Peer 3 0.50 0.50 30%
BeerCo’s is currently financed with 70% debt and 30% equity, but
use 55% and
plans to finance the new project with 55% debt and 45% equity. 45% not 70%
and 30%
Given a risk-free rate of 0.42%, an equity risk premium of 8.08%, a
required rate of return from the debtholders of 1.14% and a
marginal tax rate of 30%, should BeerCo invest in this project given
a cost of $5 billion?
Sun Inn is an American real estate company that is specialized in holiday hotels.
The company is active in North America but plans to expand to South Asia. As
such, Sun Inn is considering opening new hotels in Phuket (Thailand). Prior
making its decision, Sun Inn has performed a research study for a cost of
$100,000. The cost for building new infrastructures would amount to $150 million
today. $100,000 = sunk cost
The company's financial analysts expect that the investment will generate
additional annual revenue of $50 million during the forecast period (year 1 to year
5), growing at 10%/year. The analysts expect a stable growth rate of the FCFF of
2.5% from year 5 onwards. Annual cash operating expenses will amount to 40% of
annual revenue. Investment will be depreciated straight-line over a 15-year
period. Working capital will be 10% of annual revenue, and will need to be
available at the beginning of each year. Sun Inn marginal tax rate in Thailand will
be 25%.
The company’s current WACC is 7% but Sun Inn estimates a 8.30% WACC for its
new project. we use 8.30% and not 7%
What is the Net Present Value (NPV) of the project?


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October 26th, 2018

In valuing M2’s project, which incremental revenue should the company’s

What is the Net Present Value (NPV) of the project?

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