Question
Amazon wants to make and sell its own smartphones. It will cost $100 million initially to build the factory over the course of 12 months,
Amazon wants to make and sell its own smartphones. It will cost $100 million initially to build the factory over the course of 12 months, which will be sold for $80 million 10 years after production starts. The factory will be depreciated linearly to $0 over 10 years. Amazon already owns the land on which the factory will be built. The land is currently worth $10 million and was purchased for $2 million eight years ago.
After completion of the factory at the end of year 1, Amazon expects earnings before interest and taxes (EBIT) of $31 million each year for 10 years (in years 2 to 11). The company also has to add inventory (components) worth $5 million just before operation starts at the end of the first year.
Amazon's marginal tax rate is 28% and its cost of capital is 7%.
1. What is capital expenditure in year 0, i.e., at the start of the project (in $ million)?
2. What is the free cash flow in year 0 (in $ million)?
3. What is the free cash flow in year 1 (in $ million)?
4. What is the annual depreciation in year 2 (in $ million)?
5. What is the free cash flow in year 2 (in $ million)?
6. What is the after-tax salvage value of the factory in year 11 (in $ million)?
7. What is the free cash flow in year 11 (in $ million)?
8. What is the NPV of this project (in $ million)?
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