Minicase solution, Chapter 10
Principles of Corporate Finance, 11th Ed.
R. A. Brealey, S. C. Myers and F. Allen
The attached Excel spreadsheet was prepared by George Chavez for the proposed Downeast Tourist Mall. The spreadsheet will carry out the various sensitivity and breakeven analyses suggested in the minicase.
Enter changes in the inflation rate and forecast errors for rental revenues and share of retail sales in the spreadsheet’s left hand panel. To see the effect of a year’s delay in startup, enter 0 if no delay and 1 is start up is delayed one year. Changes in the timing and amount of construction costs should be entered directly in the cash flow table.
All cash flows except depreciation are forecasted in real terms. Note that depreciation is not subtracted in calculating operating cash flow. Depreciation tax shields are valued separately by discounting at the nominal rate. We isolated these tax shields to see the effect of changes in inflation. Inflation affects the PV of depreciation tax shields, which are fixed in nominal terms. The other cash flows are given in real terms and discounted at (1.09/1.02) – 1 = .0686.
The project’s terminal value is $30 million, the value of the land in year 18, or in year 19 if construction and startup are delayed.
If all goes as planned, the project’s NPV is + $36.6 million, but cash flows could turn out worse or better than projected. For example, a 20 per cent shortfall in rentals and share of retail sales cuts NPV to - $1.1 million.
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