Rainwater Venture Capital would like to know whether an investment in a start-up company is worthwhile. The start-up company (Project X) will only trade for two years and has forecast operating profits of 30m and 35m over the next two years. It estimates 5m will be spent on additional fixed assets in Year 2. Depreciation will be 2m per year and asset replacement will cost 50% of the annual depreciation charge. The tax rate is 20%.

REQUIRED

1. Calculate the Free Cash Flow (FCF) for Year 1 and 2 for the start-up.
2. If the start-up would cost Rainwater 40m to buy (paid immediately), advise Rainwater on whether or not it should purchase the firm. You can assume the appropriate discount rate is 12%.
3. Suppose another project (Project Y) would give 9.2m to Rainwater per year for 7 years starting next year in exchange for 40m investment today. Would this be a good investment for Rainwater?
4. If Rainwater only had 40m to invest, based on the above information, what advice would you give the company?
5. Calculate the Pay Back Period for Project Y.
6. The three most common project appraisal methods are Net Present Value (NPV), Pay Back Period and Internal Rate of Return (IRR). Compare and contrast in detail these three techniques.