Scenario

The scenario and data below is from the reading, 'Note on the Airbus A$3$XX$\text{'}.$ Assume Year $0($time of case$)$ is $2000.$

In prior classes, cash outflows usually occurred once in Year $0,$ which assumes the initial investment happens very quickly before Year $1$ begins.

Revenues and profits usually start in Year $1,$ indicating that the sales process and cash inflows can begin almost immediately.

In this Airbus case, however, the investment period $($i$.$e$.$ cash outflows$)$ actually takes $8$ years $($time for plane to be developed$)$ and is named the $\text{'}$R&D Phase' below.

It is not until Year $9(2009)$ that sales and profis $($i$.$e$.$ cash inflows$)$ can occur and is named the 'Selling Phase' below.

When there's such a long investment period and profits are delayed so far into the future, using NPV $($and discounting$)$ ensures proper accounting of the time value of money.

R&D Phase $($cash outflows$)$

Assume $10-$year straightline depreciation $($for CapEx only$)$ with no salvage value and that depreciation starts in the same year the CapEx occurs.

Assume a $11\%$ cost of capital and a $38\%$ tax rate. Calculate the NPV of the project from $2000$ to $2008($the R&D phase$).$

Assume R&D$-$related FCF starting $2009$ is $0($e$.$g$.$ CapEx offsets depreciation during this and future years$).$

Hint: It's ok if taxes are negative $($assume that losses here will be used to offset taxable profits from Airbus' other divisions$).$

Key Assumptions and Output

Discount rate $11\%$ NPV $($$ Express NPV in Year $2000$ dollars

Tax rate $38\%$

$($$ Mil$)/$ Year $200020012002200320042005200620072008$

R&D $1,1002,2002,2002,2001,320880660440$

Depreciation $02560?????$

Operating Income $????????$

Taxes $????????$

NOPAT $????????$

Depreciation $02560?????$

CapEx $025035035050000$

NWC Increase $01503003002005000$

FCF $????????$

Selling Phase $($cash inflows$)$

Assume that sales begin during the year $2009.$ For this part of the analysis, assume FCF $=$ NOPAT $($e$.$g$.$ no CapEx, depreciation, or NWC changes$).$

How many A$3$XX$$s does Airbus need to sell per year $($assume constant per year$)$ in perpetuity for the project to breakeven $($NPV $=0)?$

Note that Airbus doesn't literally need to sell this plane forever. Assuming the same perpetual cash flow allows us to simplify the problem and apply the perpetuity formula.

Otherwise, we would need to model $30$ years of cash flows. The perpetuity formula is a good approximation of $1$ to $30$ Year cash flows because the additional $31$ to infinity

cash flows doesn't significantly change the NPV$.$ Very distant cash flows have very little present value when discounted by a modest discount rate.

So use the formula for a growing perpetuity that is in the Note on Present and Future Values $($and assume perpetual growth rate equals inflation below$).$

Do you think this is a good investment?

Key Assumptions and Output

Discount rate $11\%$ Plane price $($$ mil$)225$

Tax rate $38\%$ Operating margin $18\%$

Inflation $2\%$

$2009$ FCF per sold plane $($$ Mil assume FCF $=$ NOPAT

$2008$ PV of selling one plane each year in perpetuity starting $2009($$ Mil apply Perpetuity Formula here to FCF above

$2000$ PV of selling one plane each year in perpetuity starting $2009($$ Mil discount above to $2000$ for comparability to R&D Phase NPV

Required sold planes each year in perpetuity to breakeven $($i$.$e$.$ NPV PV from selling planes each year in perpetuity must offset R&D Phase NPV

Total required sold planes from $2009$ to simply multiply above for each year beginning $2009$ through $2020$