Applied Managerial Economics
Over lunch, you and Lester meet to discuss your next assignment.
“The board of directors has been working on the cost and benefits of various expansion options,” he says. “We have developed the numbers for one scenario in this spreadsheet, and we want you to review it,” he says handing it to you.
“So you’re looking for me to use present value analysis to discount the cash flows,” you say. “Should I include the calculations for net income, operating cash flows, free cash flows, and the present value cash flows and net present value (NPV) in the spreadsheet?”
“Yes,” he says. “We want to know if the project has a positive or negative NPV. Also, in 500 words or less, explain the implications for AutoEdge and its shareholders if there is a positive NPV or, conversely, if there is a negative NPV.”
“This will be interesting,” you say.
“Good,” he says. “Oh, and one more thing. In addition to considering the NPV value, we want to know what kind of economic assumptions you think the board should consider. Articulate the economic and political risks with the strategy, and list options to overcome them. How will this decision affect the share price and the value of the company? In light of all this information, would you support the option for expansion abroad or relocate back to the United States? Include an explanation of your response, as well.”
“I’ll get right on it,” you say.
Complete spreadsheet and 500 words for assignment
Year Today Time 1 Time 2 Time 3 Time 4 Time 5 Time 6
Cost of Capital 6% 6% 6% 6% 6% 6%
(US$ in millions)
Revenue $30.10 $34.20 $38.10 $40.40 $45.60 $50.00
Selling, General, Admin ($16.10) ($17.20) ($18.90) ($19.50) ($21.40) ($24.30)
Depreciation ($4.10) ($4.40) ($4.80) ($4.90) ($5.30) ($5.70)
Interest Expense ($0.45) ($0.56) ($0.69) ($0.73) ($0.78) ($0.81)
Taxes ($1.10) ($1.30) ($1.70) ($1.90) ($2.00) ($2.10)
Change in fixed assets ($1.30) ($2.40) ($0.90) $0.00 ($4.90) ($2.10)
Students need to calculate the following:
Net Income $8.35
Depreciation added back $4.10
Change in fixed assets ($1.30)
Free Cash Flow $11.15
Pvif factor 0.943 0.890 0.840 0.792 0.747 0.705
PV Cash flows $10.51
Value of future flows
Initial expenditure ($18.00)
The initial project was funded using an $18,000,000 bank loan carrying a 6% interest rate, i.e., the cost of capital.
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