Original Proposal: (all expected numbers are incremental)

Initial outlay = $ 10 million

Earnings Before Interest and Tax (end of year 1) = $1.5 million

Corporate Tax rate = 28%

Depreciation & Amortization = $ 1 million

Change in Current Assets = $100,000

Change in Current Liability = $70,000

Salvage value = NONE

Note: The projects initial outlay will be incurred RIGHT IN THE BEGINNING OF the first year (e.g. t = 0). For lack of better information, Mishra estimates that the actual first-year 4 cash inflow (e.g. t = 1) from the project will continue for the entire ten-year life.

However, being concerned about uncertainty around this new investment, Neena proposed another alternative to Dusty-rid that calls for a partnership (co-investment) with SVC. To mitigate the risk to SVC even further, Neena added to this alternate deal that Dusty-rid must provide SVC with an exit strategy. Specifically, after five years of the super-filter project, SVC can choose to sell the part of the project that it owns to Dusty-rid at a fixed price. Neena then asked Dusty-rid management to name the price. In a few days, Dusty-rid came back with the price as $3 million. Apparantly, the partnership alternative represents a smaller scale operation to SVC. Projected numbers based on this alternative itself are given as follows:

Alternative Proposal: (all expected numbers are incremental, and to SVC) I

initial outlay = $ 7 million

Earnings Before Interest and Tax (end of year 1) = $ 1,100,000

Corporate Tax rate = 28%

Depreciation & Amortization = $ 700,000

Change in Current Assets = $50,000

Change in Current Liability = $35,000

Salvage value = NONE

Other relevant pieces of information are given as follows:

- The discount rate that reflects the riskiness in air-conditioning industry is 9%

- The New Zealand 10 Year Government Bond yield is 4.38%

- The variance of share returns on renovation industry in New Zealand is 36%

- The decay rate can be assumed as equal in each year throughout the life of the project

- Lets use e = 2.71828

QUESTIONS

1. calculate the worth of each alternative accordingly. Please show DETAILED workings

2. At what Exit price would the two alternatives be identical in their worths.

3. Write a Executive Summary to Neena to advise which alternative should be pursued by SVC. In the process, make use of numbers you calculated from Questions 1 and 2 for justifications. Also provide the points to be cautious about in your analysis.