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    Class 1 - Solutions

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    MCamille
    The document discusses several corporate finance concepts and calculations, including: 1) How changes in revenues, expenses, and depreciation affect after-tax profits and cash flow. 2) How to calculate the net present value (NPV) of a project using a discounted cash flow model. 3) The importance of sensitivity analysis by examining a project's performance under different scenarios for variables like price, costs, and sales volume. 4) How to calculate break-even points for units sold and revenues to cover fixed and variable costs.

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    Class 1 - Solutions

    Uploaded by

    MCamille
    30 views2 pages
    The document discusses several corporate finance concepts and calculations, including: 1) How changes in revenues, expenses, and depreciation affect after-tax profits and cash flow. 2) How to calculate the net present value (NPV) of a project using a discounted cash flow model. 3) The importance of sensitivity analysis by examining a project's performance under different scenarios for variables like price, costs, and sales volume. 4) How to calculate break-even points for units sold and revenues to cover fixed and variable costs.

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    The document discusses several corporate finance concepts and calculations, including: 1) How changes in revenues, expenses, and depreciation affect after-tax profits and cash flow. 2) How to calculate the net present value (NPV) of a project using a discounted cash flow model. 3) The importance of sensitivity analysis by examining a project's performance under different scenarios for variables like price, costs, and sales volume. 4) How to calculate break-even points for units sold and revenues to cover fixed and variable costs.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    30 views2 pages

    Class 1 - Solutions

    Uploaded by

    MCamille
    The document discusses several corporate finance concepts and calculations, including: 1) How changes in revenues, expenses, and depreciation affect after-tax profits and cash flow. 2) How to calculate the net present value (NPV) of a project using a discounted cash flow model. 3) The importance of sensitivity analysis by examining a project's performance under different scenarios for variables like price, costs, and sales volume. 4) How to calculate break-even points for units sold and revenues to cover fixed and variable costs.

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    © All Rights Reserved
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    Download as pdf or txt
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    Session 1 Solution

    1.
    a. (Revenue – expenses) changes by $1 million – $0.5 million = $0.5 million.
    After-tax profits increase by $0.5 million  (1 – 0.35) = $0.325 million.
    Because depreciation is unaffected, cash flow changes by the same amount.

    b. Expenses increase from $5 million to $6.5 million.


    After-tax income and cash flow decrease by:
    $1.5 million  (1 – 0.35) = $0.975 million
     1 1 
    c. The 12%, 10-year annuity factor is:  − 10 
    = 5.65022
     0.12 0.12  (1.12) 
    2.

    a. See Excel. NPV $2 million.


    b. The effect on NPV equals the change in C  5.65022. $0.325 million  5.65022 = $1.836 million
    $0.975 million  5.65022 = $5.509 million

    c. Fixed costs can increase up to the point at which the higher costs (after taxes) reduce NPV by $2 million:
    Increase in fixed costs  (1 – T)  annuity factor (12%, 10 years) = $2 million
    Increase in fixed costs  (1 – 0.35)  5.65022 = $2 million
    Increase in fixed costs = $544,567
    3.

    Why is sensitivity analysis useful? - Example


    Base Case: Expected cash flows from a new project (with 8%
    Opportunity Cost of Capital; 40% average tax rate; variable costs
    are a constant 80% of sales; all numbers in $000s)
    Year 0 Years 1-12
    Investment -5,400 Calculate:
    Sales 16,000
    NPV = $1,382.47
    Variable Costs (12,800)
    Fixed Costs (2,000) IRR = 12.7%
    Depreciation (450) Payback Period = 6 years
    Pretax profit 750
    Profitability Index = .256
    Taxes (300)
    Profit after tax 450
    Operating cash flow 900
    Net Cash Flow -5,400 900
    10-
    10-9

    4.
    Most Likely Best Case Worst Case
    Price $50 $55 $45
    Variable cost $30 $27 $33
    Fixed cost $300,000 $270,000 $330,000
    FIN520 Corporate Finance
    [email protected]
    Fitzsimons & Co. Eurl www.yourcfo.fr
    Course notes to assist non Anglophone students. These notes are not to be copied or distributed outside the above-mentioned course. They are intended merely to
    supplement private study. Reference must be made to the course textbook Brealey, Myers, Marcus Fundamentals of Corporate Finance (10th edition); McGraw Hill
    International edition).Course URL version is recommended: https://connect.mheducation.com/class/c-fitzsimons-a-bmi-3-corporate-finance-group-1-and-group-2
    Sales 30,000 units 33,000 units 27,000 units
    Cash flow = [(1 – T)  (revenue – cash expenses)] + (T  depreciation)
    Depreciation expense = $1 million/10 years = $100,000 per year
    12%, 10-year annuity factor as in question 2 = 5.65022
    a. Base-case CF = 0.65  30,000  ($50 – $30) – $300,000] + (0.35  $100,000) = $230,000
    Base-case NPV = (5.65022  $230,000) – $1,000,000 = $299,551
    b. Best-case CF = 0.65  [33,000  ($55 – $27) – $270,000] + (0.35  $100,000) = $460,100
    Best-case NPV = (5.65022  $460,100) – $1,000,000 = $1,599,666
    c. Worst-case CF = 0.65  [27,000  ($45 – $33) – $330,000] + (0.35  $100,000) = $31,100
    Worst-case NPV = (5.65022  $31,100) – $1,000,000 = –$824,278
    d. If price is higher—for example, because of inflation—variable costs may also be higher. Similarly, if price is high
    because of strong demand for the product, then sales may be higher. It doesn’t make sense to formulate a scenario
    analysis in which uncertainty in each variable is treated independently of all other variables.

    5. a. Each dollar of sales generates $0.60 or 60% of pretax profit. Depreciation expense is $100,000 per year, and fixed costs are
    $200,000. Therefore:
    Accounting break-even revenue = ($200,000 + $100,000)/60% = $500,000
    Accounting break-even units = ($200,000 + $100,000)/$60. The firm must sell 5,000 diamonds annually.
    b. Let Q = the number of diamonds sold.
    Cash flow = [(1 – 0.35)  (revenue – expenses)] + (0.35  depreciation)
    = [0.65  (100Q – 40Q – 200,000)] + (0.35  100,000)
    = 39Q – 95,000
    12%, 10-year annuity factor as in question 2 = 5.65022
    Therefore, for NPV to equal zero:
    (39Q – 95,000)  5.65022 = $1,000,000  Q = 6,974 diamonds per year.

    FIN520 Corporate Finance


    [email protected]
    Fitzsimons & Co. Eurl www.yourcfo.fr
    Course notes to assist non Anglophone students. These notes are not to be copied or distributed outside the above-mentioned course. They are intended merely to
    supplement private study. Reference must be made to the course textbook Brealey, Myers, Marcus Fundamentals of Corporate Finance (10th edition); McGraw Hill
    International edition).Course URL version is recommended: https://connect.mheducation.com/class/c-fitzsimons-a-bmi-3-corporate-finance-group-1-and-group-2

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