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Capital

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Capital Budgeting
Assignment #2
Breana N. Rainge

23. Bauer Industries is an automobile manufacturer. Management is currently evaluating a proposal to build a plan that will manufacture lightweight trucks. Bauer plans to use a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental free cash flow projections (in millions of dollars):

| Year 0| Year 1-9| Year 10|
Revenues| | 100.0| 100.0|
-Manufacturing expenses (other than depreciation)| | -35.0| -35.0| -Marketing expenses| | -10.0| -10.0|
-Depreciation| | -15.0| -15.0|
=EBIT| | 40.0| 40.0|
-Taxes (35%)| | -14.0| -14.0|
=Unlevered net income| | 26.0| 26.0|
+Depreciation| | +15.0| +15.0|
-Increases in net working capital| | -5.0| -5.0|
-Capital expenditures| -150.0| | |
+Continuation value| | | +12.0|
=Free cash flow| -150.0| 36.0| 48.0|

A. For this base-case scenario, what is the NPV of the plant to manufacture lightweight trucks? B. Based on input from the marketing department, Bauer is uncertain about its revenue forecast. In particular, management would like to examine the sensitivity of the NPV to the revenue assumptions. What is the PV of the project if revenues are 10% higher than forecast? What is the NPV is revenues are 10% lower than forecast? C. Rather than assuming that cash flows for this project are constant, management would like to explore the sensitivity of its analysis to possible growth in revenues and operating expenses. Specifically, management would like to assume that revenues, manufacturing expenses, and marketing expenses are as given in the table for year 1 and grow by 2% per year every year starting in year 2. Management also plans to assume that the initial capital expenditures (and therefore depreciation), additions to working capital, and continuation value remain as initially specified in the table. What is the NPV of this...

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