Course: Capital Budgeting

The question is about the file labeled "HELP" but the information on "Before" carries over to "HELP" Everything we are currently covering in class is on the top part of the excel sheet on "Before" if anything needs to be made clear refer to that.

I am not 100% sure as my professor is extremely vague and does not accept individual questions as he sees it as an unfair advantage, which is why Im trying to get some help. But I think its asking to restate the time lines, cash flow, and business valuation using the new valuations stated. He briefly mentioned this was to see how inflation/deflation effected those sorts of valuations that are on "Before" Must be done in excel, and work shown. CAN NOT be expressed in words. Using the information, valuations, timelines from "Before" and then using the numbers on "HELP" to show how they will change the results

REVIEW OF KEY CONCEPTS, LAST LECTURE FINANCIAL STATEMENTS and INFORMATION > Accounting formats (P&L, Balance Sheet, Cash Flow) required > Accounting data only goes so far - analytics govern > Algebraic derivation of cash flow and taxes is utterly bogus > Governing concepts [finance, accounting, economics (micro)] - fixed / variable costs and contribution - direct costing - relevant costs w/r/t the capital budgeting approach 4a ENTERPRISE VALUATION METHOD ELEMENTS OF ONE-EQUATION VALUATIONS > Usage in the terminal value problem SPECIAL PROBLEMS > Working Capital > Disposal values > Investment tax credit 5 base points + 2 = 7 total The CEO of social media company FacePlant is unhappy with the resulting analysis. She comments, 'This project is so big, effectively it will represent our entire company by the end of The FacePlant CFO then says, 'I'm glad the Harvard guy is gone. It appears to me he made a mistake on the depreciation. It should be 10X the amounts shown on the statements. I co Initially, FacePlant has essentially no long term assets, but it does have some current account activity due to other operations. All the other numbers are attributable to the project. The Chairman of the Board looks at you and says, "I need a new cash flow analysis reflecting the changes. I also need an understanding of all the various terminal values you can gene Where appropriate assume the following, but be aware the statements were assembled by a newby and may or may not be correct and his data may not be relevant. 300 million shares outstanding 12 P/E of competitors 2.5 Price-to-EBITDA for this industry, from Yahoo! Finance 40% tax rate 250,000 project CAPEX 1.2 competitor price-to-book (an MVA metric) 10% typical write-down of asset liquidations in this industry 11% cost of capital 2% horizon cash flow growth BALANCE SHEET ASSETS Cash Accounts Receivable Inventory 0 5,000 15,000 20,000 1 54,850 15,450 20,600 2 104,700 15,900 21,200 3 154,550 16,350 21,800 4 204,400 16,800 22,400 Fixed assets (OAC) less Acc. Depr. NBV 250,000 0 250,000 250,000 -100,000 150,000 250,000 -180,000 70,000 250,000 -230,000 20,000 250,000 -250,000 0 TOTAL ASSETS 290,000 240,900 211,800 212,700 243,600 LIABILITIES Current Liabilities Debt TOT Liabilities 30,000 15,000 45,000 30,900 14,250 45,150 31,800 13,538 45,338 32,700 12,861 45,561 33,600 12,218 45,818 Equity 245,000 195,750 166,463 167,139 197,782 TOTAL LIABILITIES AND EQUITY 290,000 240,900 211,800 212,700 243,600 Sales COS Gross Margin 0 0 0 0 1 200,000 80,000 120,000 2 200,000 80,000 120,000 3 200,000 80,000 120,000 4 200,000 80,000 strictly variable cost 120,000 + allocations "Decrease in Contribution of Other Products" Adjusted Gross Margin 0 0 0 3,000 -15,000 108,000 3,000 -15,000 108,000 3,000 -15,000 108,000 3,000 newby added these back. They are known to be -15,000 newby believed this adjustment was appropriate 108,000 SG&A "Interest on bonds expected to be used" PBT - tax PAT 0 18,000 -18,000 -7,200 -10,800 40,000 18,000 50,000 20,000 30,000 40,000 18,000 50,000 20,000 30,000 40,000 18,000 50,000 20,000 30,000 40,000 strictly variable cost 18,000 50,000 20,000 30,000 CASH FLOW STATEMENT PAT + Depreciation Cash Flow from Operations -10,800 ?? 30,000 ?? 30,000 ?? 30,000 ?? 30,000 ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? ?? CASH FLOW ?? ?? ?? ?? ?? P&L Cash Flow balance sheet items ?? SOLUTIONS RESTATED FINANCIALS FOR THE PURPOSE OF BUSINESS VALUATION social media company FacePlant 0 0 1 -100,000 -100,000 2 -180,000 -80,000 3 -230,000 -50,000 P&L 0 Sales Depr. Exp. COS Gross Margin 0 1 200,000 100,000 80,000 20,000 2 200,000 80,000 80,000 40,000 3 200,000 50,000 80,000 70,000 4 200,000 given 20,000 250,000 include - could be COS or somewher 80,000 100,000 + allocations "Decrease in Contribution of Other Products" Adjusted Gross Margin 0 -15,000 5,000 0 -15,000 25,000 0 -15,000 55,000 0 direct costs must not be subtracted out -15,000 OK 85,000 SG&A "Interest on bonds expected to be used" PBT - tax PAT 40,000 0 -35,000 -14,000 -21,000 40,000 0 -15,000 -6,000 -9,000 40,000 0 15,000 6,000 9,000 Acc. Dep. Depr. Expense implied RESTATED BALANCE SHEET Cash Accounts Receivable Inventory 4 -250,000 -20,000 -250,000 PROOF 40,000 OK 0 take out - irrelevant 45,000 18,000 marginal, incremental and dynamic...a negative 27,000 NOTE: Sometimes the actual relevant deltas are so simple a full-blown balance sheet is not necessary. Th 0 1 2 3 4 -250,000 -176,150 -105,300 -46,450 400 IRRELEVANT. No beginning balance (related to 15,450 15,900 16,350 16,800 No beginning balance (related to other operati 20,600 21,200 21,800 22,400 Fixed assets (OAC) less Acc. Depr. NBV 250,000 0 250,000 250,000 -100,000 150,000 250,000 -180,000 70,000 250,000 -230,000 20,000 250,000 -250,000 0 TOTAL ASSETS 0 9,900 1,800 11,700 39,600 LIABILITIES Current Liabilities Debt TOT Liabilities 0 30,900 0 30,900 31,800 0 31,800 32,700 0 32,700 33,600 No beginning balance related to other operatio 0 Irrelevant 33,600 Equity 0 -21,000 -30,000 -21,000 6,000 Irrelevant for Enterprise valuation - shown here TOTAL LIABILITIES AND EQUITY 0 0 9,900 0 1,800 0 11,700 0 39,600 Irrelevant for Enterprise valuation - shown here 0 test NOTE HOW THIS "END-GAME TEST" TIES TOGET -21,000 100,000 79,000 -9,000 80,000 71,000 9,000 50,000 59,000 27,000 20,000 add back 47,000 0 0 0 CASH FLOW STATEMENT PAT + Depreciation Cash Flow from Operations CAPEX Working Capital Incr. - AR Incr. - Inventory Incr. - Curr. Lia. CASH FLOW Cash, beg. +/- cash flow Cash, end ANSWER: -250,000 0 nothing in T0 --- relates to other projects -450 incremental deltas - note T1 unique calc -600 incremental deltas - note T1 unique calc 900 incremental deltas - note T1 unique calc, and si -15,450 -20,600 30,900 -450 -600 900 -450 -600 900 -250,000 73,850 70,850 58,850 46,850 0 -250,000 -250,000 -250,000 73,850 -176,150 -176,150 70,850 -105,300 -105,300 58,850 -46,450 -46,450 46,850 400 Note: depreciation and other methods changes are not optional: they are a matter of essentially irreversable tax elections.. SOME OBVIOUS ANSWERS... (1) IF LIQUIDATE OR DIVEST TODAY AND NOT MAKE THE INVESTMENT, NPV = SIMPLE LIQUIDATION 5,000 Cash 15,000 Accounts Receivable 20,000 Inventory -3,500 LESS typical asset write down -45,000 TOT Liabilities -8,500 VALUE OF EXISTING NET ASSETS DIVEST - HYBRID RATIO METHOD is FacePlant public? ...is a public proxy valuation germane? P/E 12 P/E of competitors 0 Earnings absent project 0 = 0 x 12 EBITDA MULTIPLE 2.5 0 EBITDA absent project 0 = 0 x 2.5 PRICE-to-BOOK 294,000 = 1.2 x 245000 somewhat goofy...ignored in what follows (2) Typical Discounted Cash Flow ("DCF") analysis... THERE ARE ACTUALLY TWO FLAVORS HERE, THE PURE PROJECT VALUATION AND THE BUSINESS VALUATION... PROJECT VALUATION 11% cost of capital TIME discounting factors CASH FLOW PV NPV 0 1 2 3 4 1 0.9009009009 0.811622433 0.7311913813 0.658730974 -250,000 73,850 70,850 58,850 46,850 -250,000.000 66,531.532 57,503.449 43,030.613 30,861.546 -52,072.860 BUSINESS VALUATION -60,572.860 NPV + VALUE OF EXISTING ASSETS No other of the initial liquidation values are combined with the Project NPV, since it is not possible to divest and Invest at t NUANCES > The initial liquidation value is IRRELEVANT TO THE PROJECT since it exists regardless of whether the pro > The initial liquidation value is RELEVANT TO THE BUSINESS since it Iis a real cash flow +/- of the busines BASED ON THE QUESTIONS RAISED, THE BUSINESS VALUE IS THE BASE NPV. TERMINAL VALUE ALTERNATIVES NOTE: SYLISTICALLY THESE ARE BEST INCLUDED IN THE TIME LINE and the final answer to management would be show CASH FLOW BASED (these can be enterprise-type valuations or equity-type...we developed it as enterprise-type). THESE ARE 'BOTTOM-UP' ANALYSES. PV of NO GROWTH PERPETUITY 280,560 = T4 discounting factor x 46850 / 0.11 PV of PERPETUITY WITH GROWTH 349,764 = T4 discounting factor x 46850 x (1 + 0.02) / (0.11 - 0.02) CASH FLOW PROXY BASED (when done as ratios, these are basically enterprise-type valuations) FCF Accounts Receivable Inventory NBV less Current Liabilities 27,000 = NOPAT = EBIT x (1 - t) = 45000 x (1 - 0.4) 19,850 = delta TNOC 46,850 = FCF = identical to cash flow calculated above TNOC3 16,350 21,800 20,000 -32,700 25,450 TNOC4 16,800 22,400 0 -33,600 5,600 DELTA 19,850 THEREFORE FCF WILL EQUAL PERPETUITY METHODS ABOVE Therefore FCF-based perpetuity valuations will be enterprise-based and identical to the foregoing cash flow based methods -Both the cash flow-based method and the FCF-based method rely on a one-period cash flow -But both the cash flow-based method and the FCF-based method basically ignore the original CAPEX and use the accounting data DESPITE THAT, THE SHORT-CUT FCF METHOD IS NO SUBSTITUTE FOR A PROPERLY FORMULATED TIME LINE - It is meant as a short-cut technique for special analyses --- but even in that case a good analyst would verify F EVA 27,000 = NOPAT, as above -616 = WACC x TNOC = -cost of capital x 5600 26,384 = EVA EVA-based perpetuity valuations will not be identical to cash flow and FCF methods. -FCF will swing with balance sheet changes from year-to-year, EVA depends on net assets that exist now. -EVA takes into account all assets, including the full value of CAPEX remaining (NFA) Cash Flow FCF EVA 1 73,850 78,850 -38,067 2 70,850 70,850 -17,283 3 58,850 58,850 6,201 EVA would be capitalized in similar fashion to the previous... 158,000 EVA, discounted, no growth 196,973 EVA, discounted, with growth HYBRID RATIO BASED (these are, by definition, equity-type valuations). THESE ARE 'TOP-DOWN' ANALYSES. WHY? P/E-based 12 P/E 27,000 Y4 earnings aka PAT (this assumes look-backward P/E) 324,000 valuation before debt (this is the equity value) 4 46,850 46,850 26,384 Ties to the complete set of accounting stateme 12,218 plus long term debt (unrelated to this project - project spontaneous liabilities already accounted for)...debt value + equity val 336,218 enterprise-type value 221,477 discounted EBITDA-based 2.5 ratio 65,000 = EBITDA = EBIT + DEPR = 45000 + 20000 162,500 valuation - EQUITY-BASED 12,218 plus long term debt (unrelated to this project - project spontaneous liabilities already accounted for)...debt value + equity valu 174,718 enterprise-type value 115,092 discounted Price-to-Book - based (MVA) 1.2 ratio 197,782 Firm book value 237,339 valuation 12,218 plus long term debt (unrelated to this project) 249,556 enterprise-type value 164,391 discounted WHAT ABOUT THE INITIAL LTD? > An open question - ...part of the financing cost? ...retired during the term of the project? ...is the LTD increment really related to this - lots of possible answers ACCOUNTING (specific asset and liability - based). THIS IS A 'BOTTOM-UP' ANALYSIS. Liquidation value @ book 193,862 = Liq value of Assets + Cash - Total Liabilities 127,703 discounted TERMINAL VALUE SUMMARY -60,572.860 BUSINESS VALUATION BEFORE TERMINAL VALUE POSSIBLE ADJUSTMENTS 280,560 PV of NO GROWTH PERPETUITY, either 'cash flow' or FCF method 349,764 PV of PERPETUITY WITH GROWTH, either 'cash flow' or FCF method 158,000 EVA, discounted, no growth 196,973 EVA, discounted, with growth 221,477 P/E-based 115,092 EBITDA-based 164,391 Price-to-Book - based (MVA) 127,703 Liquidation value @ book OTHER OPTIONS -8,500.000 SIMPLE LIQUIDATION WHAT IS THE ANSWER? > depends on what you believe...AND WHAT THE ACQUIRER BELIEVES WHAT IS YOUR RECOMMENDATION??? f the 4th year.'. (The numbers are stated in thousands of dollars). She continues: 'This effectively means everything rests on the terminal value. If we are completely wrong, the company is bank orrected the error and here's how I see the Balance Sheet trend. I basically ignored our other operations because for this analysis they are insignificant.'. Then he hands you a document, shown erate. Have that for me ASAP." Completely out of the blue he then says, "Forget about the ones in Bierman & Smidt Ch.2 ADV, however. There could be a 'balloon animal' spreadsheet out there e direct allocations e re, doesn't make much difference where e tax is a special problem all to its own - NOL is the best treatment, beyond the scope of our discussion his one is shown for illustration. o other operations). Note Cash is per Cash Flow Statement, below tions). ons. e merely to illustrate balancing e merely to illustrate balancing THER ALL STATEMENTS - the genius of Renaissance era Italians ign change the same time. oject is accepted or rejected ss in all circumstances wn that way FCF against the time line ents lue = enterprise value ue = enterprise value s project? bankrupt. If we are partly wrong, we become a buy-out target. But if we get it right, we have a major exit event in the form of an IPO or a merger where we set the terms. I want a better unders own below. ere somewhere that might be valuable.". derstanding of the terminal value.'. 5% rate 6.6 OLD MACHINE OAC: NBV: DEPR. EXP: OTHER SAL. VAL, FUTURE 0% taxes 50,000 10,000 2,000 20 years ago???? 6,000 sale value 1,000 ten year out NEW MACHINE 80,000 15,000 OAC is less this amount as trade-in value 10,000 ten year out UNIT COSTS OLD MACH $4.00 $5.00 $2.50 $2.50 $10.00 10,000 Direct Labor Variable Indirect labor Other variable ovhd Fixed ovhd Sale Price Units produced and sold NEW MACH $2.00 $3.50 $4.00 $3.25 THIS IS IRRELEVANT, BY DEFINITION $10.00 10,000 PERPETUITY VALUATION, IN THIS SECTION (ECONOMIC LIFE > TAX LIFE) FIRST, IDENTIFY ALL POSSIBLE ALTERNATIVES A = SELL THE OLD MACHINE AND STOP ALL PRODUCTION B = CONTINUE TO OPERATE WITH THE OLD MACHINE C = BUY THE NEW MACHINE These are the MUTUALLY EXCLUSIVE and EXHAUSTIVE alternatives SECOND, TO AVOID THE ERRORS OF 'RELATIVE CASH FLOW' ANALYSIS, VALUE EACH AS 'ABSOLUTE' $6,000.00 sale value VALUE OF "A" NOTE: WITH TAXES, THIS CHANGES DRAMATICALLY, ASSUME 30% TAX RATE 6,000 sale value 10,000 book value -4,000 tax loss 1,200 value of tax shield assuming a 30% tax rate 7,200 value, after tax NOTE: depends upon profit elsewhere in the corp, now (or discounted value later) VALUE OF "B" CASH FLOW PER YEAR: -$1.50 Contribution Margin per unit 10,000 Volume -$15,000.00 Total Contribution PERPETUITY VALUE: -$300,000.00 SALVAGE VALUE PRESENT VALUE: $1,000.00 ten years out $613.91 NET PRESENT VALUE: -$299,386.09 NOTE: If taxes were considered, the annual cash flows would benefit from tax shield, salvage value taxes =??? VALUE OF "C" CASH FLOW PER YEAR: $0.50 Contribution Margin per unit 10,000 Volume $5,000.00 Total Contribution PERPETUITY VALUE: $100,000.00 SALVAGE VALUE PRESENT VALUE: COST OF NEW MACHINE NET PRESENT VALUE: $10,000.00 ten years out $10,000.00 -$95,000.00 on an absolute basis: without trade-in value $15,000.00 NOTE: If taxes were considered, the annual cash flows would be reduced by taxes, and, salvage value taxes =??? OPTION "C" IS THE BEST OPTION NOW, WHAT IS THE REAL VALUE OF "C", NOW THAT WE KNOW THE BEST CHOICE??? ABSOLUTE NPV OF "C" CASH FLOW FROM SALE OF OLD NET PRESENT VALUE: VALUE OF TRADE-IN NET PRESENT VALUE: $15,000.00 $6,000.00 $21,000.00 THIS IS THE RELATIVE NPV IF THE OLD MACHINE IS SOLD $15,000.00 $30,000.00 THIS IS THE RELATIVE NPV IF THE OLD MACHINE IS TRADED-IN BUY THE NEW MACHINE AND TRADE-IN THE OLD IS THE BEST OPTION VALUE WHERE TAX LIFE = ECONOMIC LIFE FIRST, IDENTIFY ALL POSSIBLE ALTERNATIVES A = SELL THE OLD MACHINE AND STOP ALL PRODUCTION B = CONTINUE TO OPERATE WITH THE OLD MACHINE C = BUY THE NEW MACHINE These are the MUTUALLY EXCLUSIVE and EXHAUSTIVE alternatives SECOND, TO AVOID THE ERRORS OF 'RELATIVE CASH FLOW' ANALYSIS, VALUE EACH AS 'ABSOLUTE' VALUE OF "A" $6,000.00 sale value VALUE OF "B" CASH FLOW PER YEAR: Index: Factor: Cash Flow per Year: Salvage Value year 10 Cash Flow per Period PV of cash flow per period: -$1.50 Contribution Margin per unit 10,000 Volume -$15,000.00 Total Contribution 1 2 3 4 5 6 7 8 9 10 0.9524 0.9070 0.8638 0.8227 0.7835 0.7462 0.7107 0.6768 0.6446 0.6139 -$15,000.00 -$15,000.00 -$15,000.00 -$15,000.00 -$15,000.00 -$15,000.00 -$15,000.00 -$15,000.00 -$15,000.00 -$15,000.00 $1,000.00 -$15,000.00 -$15,000.00 -$15,000.00 -$15,000.00 -$15,000.00 -$15,000.00 -$15,000.00 -$15,000.00 -$15,000.00 -$14,000.00 -$14,285.71 -$13,605.44 -$12,957.56 -$12,340.54 -$11,752.89 -$11,193.23 -$10,660.22 -$10,152.59 -$9,669.13 -$8,594.79 NET PRESENT VALUE: -$115,212.11 VALUE OF "C" CASH FLOW PER YEAR: Index: Factor: Cash Flow per Year: Salvage Value year 10 Cash Flow per Period PV of cash flow per period: COST OF NEW MACHINE NET PRESENT VALUE: $0.50 Contribution Margin per unit 10,000 Volume $5,000.00 Total Contribution 1 2 3 4 0.9524 0.9070 0.8638 0.8227 $5,000.00 $5,000.00 $5,000.00 $5,000.00 5 0.7835 $5,000.00 6 0.7462 $5,000.00 7 0.7107 $5,000.00 8 0.6768 $5,000.00 $5,000.00 $4,761.90 $5,000.00 $3,917.63 $5,000.00 $3,731.08 $5,000.00 $3,553.41 $5,000.00 $3,384.20 $5,000.00 $4,535.15 $5,000.00 $4,319.19 $5,000.00 $4,113.51 -$95,000.00 on an absolute basis: without trade-in value -$50,252.19 NOTE: If taxes were considered, the annual cash flows would be reduced by taxes, and, salvage value taxes =??? OPTION "A" IS THE BEST OPTION WOULD TRADING IN THE OLD MACHINE IMPROVE THE VALUE OF OPTION "C" AND CHANGE THE DECISION? NET PRESENT VALUE OF "C", ABSOLUTE: -$50,252.19 PLUS TRADE-IN VALUE OF OLD: $15,000.00 NET RELATIVE VALUE: "C" PLUS TRADE-IN: -$35,252.19 OPTION "A" IS STILL THE BEST OPTION 9 0.6446 $5,000.00 10 0.6139 $5,000.00 $10,000.00 $5,000.00 $15,000.00 $3,223.04 $9,208.70 4b 4 base points + 1 = 5 total. A note on precision: dollars are stated as rounded millions - three decimal places are OK for final NPV results, but do not aggressively rou The FacePlant Executive Committee has decided that the best termina value assumption is Liquidation value @ book, and the Time Line should include the initial Busine 1.70% expected CPI increases 2.00% deflation expected in the material portion of non-depreciation COS (40% of which is material). The non-depreciation, non-material portion will in These forecasts are reflective of the deflationary value of electronic material parts, but the increasing cost of technical personnel. Admin. cost will increase with the CPI. The company doesn't have much bargaining power with customers - the inflation-related price increases will be roughly half of CPI. The current WACC is considered reflective of nominal market rates: the Real WACC is roughly half that amount. You point out that such variables are likely to also affect Balance Sheet values - the CFO says, "Don't worry about the balance sheet...your point is valid but those numb Your mentor pulls you aside for a moment and says, "I want you to look good on this - be very careful of how you treat depreciation.". Then the CEO whisks your mento Restate the time lines, cash flow, and business valuation. What do you recommend? ressively round discounting factors or other numbers. nitial Business Value adjustment previously analyzed. They note the following additonal assumptions that must be addressed: ortion will increas at 4X CPI. hose numbers will change by a % of a %. At this point just assume the asset values, liabilities and debt will remain the same." your mentor away and they leave for an immediate safari in Borneo: You have no way of getting a clarification of that statement