Reto Sa

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Reto S.A.
Question 1:
Since we are initially ignoring the effects of taxes and do not know the required return, (we initially know only that debt costs 8% but are not provided any information regarding equity costs) the only available option is to use either a non-time value based evaluation or the internal rate of return: Cash Flow Time Amount

Equipment Cost 0 SFr -600000

Revenue 1-10 2000000
Less Commissions-15% -300000
Less Materials -600000
Less Labor -900000

Before Tax Cash Flow SFr 200000

Internal Rate of Return 31.11%

Question 2:
Introducing taxes to the problem will change the annual cash flows although they remain an annuity since the depreciation is assumed to be an equal amount each year: Cash Flow Time Amount

Equipment Cost 0 SFr -600000

Revenue 1-10 2000000
Less Commissions-15% -300000
Less Materials -600000
Less Labor -900000
Less Depreciation -60000

Before Tax Profit SFr 140000
Less Taxes at 45% -63000
After Tax Profit 77000

Add Back Depreciation 60000

Annual Cash Flow 137000

Internal Rate of Return 18.732%

Question 3:
Knowing that Torgler wants a return of 12% permits the use of the NPV approach to the problem. We know it will be a positive NPV since Question 2 indicated a IRR greater than 12%, but it would still be interesting to know the actual number. Using the cash flow data from the previous question and a discount rate of 12% yields a NPV of SFr 174,080.56 which is the Present Value of the Inflows = SFr 774,080.56 less the Present Value of the Outflows (Initial Investment) = SFr 600,000. We could also break apart the two component parts of the total cash flow into the after tax operating cash flow and the depreciation tax shield: Time Outflow Operating Profit After-Tax Depreciation Depreciation Cash Flow Present

Operating Profit Tax Shelter Value
0 -600000 -600000.00
1 200000 110000 60000 27000 137000 122321.43
2 200000 110000 60000 27000 137000 109215.56
3 200000 110000 60000 27000 137000 97513.89
4 200000 110000 60000 27000 137000 87065.98
5 200000 110000 60000 27000 137000 77737.48
6 200000 110000 60000 27000 137000 69408.46
7 200000 110000 60000 27000 137000 61971.84
8 200000 110000 60000 27000 137000 55332.00
9 200000 110000 60000 27000 137000 49403.57
10 200000 110000 60000 27000 137000 44110.33

NPV 174080.55

Question 4:
Reworking the analysis to reflect the new depreciation methodology is much easier to accomplish when the two components of the cash flow are separated as above: Time Outflow Operating Profit After-Tax Depreciation Depreciation Cash Flow Present

Operating Profit Tax Shelter Value
0 -600000 -600000.00
1 200000 110000 200000 90000 200000 178571.43
2 200000 110000 80000 36000 146000 116390.31
3 200000 110000 40000 18000 128000 91107.87
4 200000 110000 40000 18000 128000 81346.31
5 200000 110000 40000 18000 128000 72630.64
6 200000 110000 40000 18000 128000 64848.78
7 200000 110000 40000 18000 128000 57900.70
8 200000 110000 40000 18000 128000 51697.05
9 200000 110000 40000 18000 128000 46158.08
10 200000 110000 40000 18000 128000 41212.57

NPV 201863.75

Question 5:
Working capital is a relevant cash flow and can dramatically impact the NPV even though the total cash flows of investing in working capital will have no aggregate effect except for the loss of the time value: Time Outflow Operating Profit After-Tax Depreciation Depreciation Cash Flow Present

Operating...
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