Project #$4$ Crane Rental Analysis$$Risk Analysis

This project is an extension of project $2,$ for which the solution key was posted previously. Use this solution key, and make the adjustments to complete MORE analysis. Answer the following:

A$.$ What is the project$$s NPV$?$

B$.$ What is the project$$s IRR?

C$.[$All$-$equity; consider sales variance$]$ The equity contributed the $$1$ million necessary to fund the project, of course. Equity will accordingly receive the FCFFs each period. $1.)$ What is the rate of return to the equity? $[$Use the $$IRR function$$ of Excel to calculate the rate of return to the equity. $($The rate of return will not be a surprise of course.$)2.)$ Consider the following: if annual sales are $10\%$ lower than forecast with NO change in costs. What is the rate of return to the equity?

D$.[$Using some debt; consider sales variance$]$ Now assume that the firm used a different funding structure to get the capital necessary to purchase the Crane. Assume that $$400,000$ of bank debt was used, along with only $$600,000$ of equity. Repayment of the bank debt requires $$100,183$ annually at the end of each of the next five years $($it is an amortizing loan$$like the typical car loan$).$ The equity, as the residual claimant, will, of course, receive only whatever FCFF is leftover after paying the debt each year. $1.)$What is the rate of return to the debt? $2.)$ What is the rate of return to the equity? $3.)$ Now consider the following: if annual sales are $10\%$ lower than forecast with NO change in costs. $4.)$ What is the project IRR? $5.)$ What is the rate of return to the equity?

E$.[$All$-$equity vs$.$ using some debt; equity return sensitivity to sales variance$]$ Discuss how sensitive the following are to annual sales $10\%$ lower than forecast with NO change in costs: $1.)$ How much does Project IRR fall?, $2.)$ How much does the return to the equity fall when using debt, and when not using debt? $3.)$ How does the use of debt effect the volatility in equity returns $($i$.$e$.$ does use of debt impact equity return? Does use of debt make equity returns more stable or more volatile?

Original Project $2$ language follows:

The firm founder purchases a construction crane to rent out. Only equity capital is used, no debt. The terms of the rental are such that the services of a crane operator are included in the lease of the equipment, in a manner similar to the Taxi analysis, wherein the taxi provides the vehicle, and driver.

The firm is contemplating the following:

Crane acquisition cost $ $1,000,000$

Years of useful life $($economic life$)5$

Tax rate $0\%$

Required rate of return on equity $10\%$

Annual revenues $ $2,000,000$

Operating expenses include only: $$Other expenses$$ of $$1,500,000,$ plus depreciation.

Tips:

$1.$Depreciate straight$-$line over the years of useful life down to $$0.$ The Crane will be disposed of at end of the fifth year at no cost$.$

$2.$ The maximum dividend is paid annually.

$3.$ Ignore any working capital effects.

$4.$ Capital charge will be based on the assets at the beginning of each year.

$5.$ If the taxi spreadsheet is used as a starting point to develop a spreadsheet for the analysis, there will still be significant additional work to be done to complete this project.

Please include in the analysis:

$1.$ FINANCIALS: Annual P&Ls

a$.$ Note annual operating margin.

b$.$ What is year $1$: Return on Asset? Return on Equity? EBITDA?

$2.$ CASHFLOW ANALYSIS:

a$.$ OCF analysis

b$.$ Economic Profit analysis

$3.$ PROJECT SELECTION: Does this project deserve consideration?

$4.$ WEALTH CREATION: How much wealth, if any, will the investment in the project create?

$5.$ VALUATION: assume the market is efficient, and the market agrees with your analysis of the project. Immediately after making the investment: what is: the Enterprise Value? Enterprise value as a multiple of EBITDA?

$6.$ MERGER & ACQUISITION: Five minutes after the founder invests in the project the founder receives an offer to purchase the project for $5$X EBITDA. Answer these:

a$.$ All$-$else$-$equal briefly address the merit, if any, of the founder accepting the offer.

b$.$ If the project is acquired, will the Acquirer realize the same$/$higher$/$lower rate of return on their investment that the Seller would have earned on their investment? No need to calculate a rate of return, just answer the question conceptually.