Capital Budgeting
Example 2
Mai Linh is a fashion chain. It is considering introducing a new line of African fashion in its
Mai Linh paid Tuan Bach $0.5mn to research the market. The results suggest that custome
Expected annual sales $25 mn first year, increase 10% each year. Costs of sales 35% of sale
Upfront R&D and marketing expenses $10 mn. No upfront investment needed. No new sh
Additional R&D, advertising, selling, advertising and general costs $5 mn each year.
As suppliers requires prepayments, upfront working capital requirements $2.5 mn increas
African fashion to be trendy in 4 years. Then noone will buy thus Mai Linh will stop selling.
At the end of year 4, working capital reduced by the amount invested for the project.
Corporate tax rate 40%. Debt-Equity ratio 1:1. Costs of equity and pre-tax debt are 10% an
Debt-equity ratio to remain constant.
a) Evaluate the project.
b) Customers buying African fashion will reduce consumption of other lines such as Asian
Loss from other lines expected to be $5. Evaluate the project.
d) Suppose African Fashion will remain trendy forever but sales will stop growing after yea
Evaluation of the Project
STEP 1: ESTIMATE FREE CASH FLOW
a) Estimation of Free cash flows figures in $ mn
Year 0 1 2 3 4
Sales
less Costs of sales
Gross Profit
less Operating expenses
EBIT
less Income tax @40%
Unlevered Net Income
Free Cash Flow
STEP 2: ESTIMATE THE COST OF CAPITAL
WACC = 0.5*10+0.5*6*(1-0.4)
= 6.8 %
STEP 3: CALCULATE NPV
b) NPV = -10+9/1.068+9/1.068^2+9/1.068^3+9/1.068^4
= 20.623
African fashion in its European shops.
suggest that customers like African fashion.
ts of sales 35% of sales.
t needed. No new shops.
mn each year.
ents $2.5 mn increase 25% each year to support sales growth.
Linh will stop selling.
d for the project.
e-tax debt are 10% and 6% respectively.
r lines such as Asian and Latin Fashion.
top growing after year 4 . Evaluate the project.
Example 2
Mai Linh is a fashion chain. It is considering introducing a new line of African fashion in its
Mai Linh paid Tuan Bach $0.5mn to research the market. The results suggest that custome
Expected annual sales $25 mn first year, increase 10% each year. Costs of sales 35% of sale
Upfront R&D and marketing expenses $10 mn.
Mai Linh won't need to open new shops, but will have to invest in new shelves and furnitu
The cost of these fixed assets is $30 million, to be fully depreciated on a straight-line basis
Additional R&D, advertising, selling, advertising and general costs $5 mn each year.
African fashion to be trendy in 4 years. Then noone will buy thus Mai Linh will stop selling.
Corporate tax rate 40%. Debt-Equity ratio 1:1. Costs of equity and pre-tax debt are 10% an
Debt-equity ratio to remain constant.
As suppliers require prepayments and inventory of African clothes is needed, working cap
When the company stop selling African fashion, all African clothes are sold and prepayme
Table 1 Year 0 1 2
Additional inventory ($mil) +3 +1 +1
Increase in receivables due to prepayments ($mil) +2 +0.5 +0.5
Evaluate the project. 5 1.5 1.5
year 0 1 2 3 4
sales 0 25 27.5 30.25 33.275
CoS 0 -8.75 -9.625 -10.588 -11.646
gross profit 0 16.25 17.875 19.663 21.629
operating expenses -10 -5 -5 -5 -5
dep 0 -7.5 -7.5 -7.5 -7.5
ebit -10 3.75 5.375 7.1625 9.12875
tax 4 -1.5 -2.15 -2.865 -3.6515
unlevered net income -6 2.25 3.225 4.2975 5.47725
NCC 0 7.5 7.5 7.5 7.5
WCI -5 -1.5 -1.5 -1.5 9.5
FCI -30 0 0 0 3 4.172
FCFF -41 8.25 9.225 10.2975 25.47725
PV -41 7.724719 8.087678 8.45314 19.58247
cummulative FCFF -41 -32.75 -23.525 -13.2275 12.24975
cummulative PV -41 -33.27528 -25.1876 -16.73446 2.84801
The cost of these fixed assets is $30 million, to be fully depreciated on a double declining balance in 6 years. After 4
year 1 2 3 4 5 6
open balance 30 20 13.34 8.9
DDB dep 10 6.66 4.44 2.96
straight line 5 4 3.335 2.97 2.97 2.97
closing 20 13.34 8.9
book value = open - dep = 30 - (10+6.66+4.44+2.97) = 5.93
FCI 4 = tiền bán thanh lý - (tiền bán - book value) x tax = 3 - (3-5.93)x40% = 4.172
African fashion in its European shops.
suggest that customers like African fashion.
ts of sales 35% of sales.
w shelves and furnitures to exhibit African fashion in current shops.
n a straight-line basis in 4 years. After 4 years, they can be sold for $3 million.
mn each year.
Linh will stop selling.
e-tax debt are 10% and 6% respectively.
needed, working capital accounts are expected to change as in Table 1.
e sold and prepayments stop, inventory and receivables will return to the initial levels.
3 4
+1 -6 double declining method
+0.5 -3.5 depreciation rate = 1/n x 2 x 100 = 1/4 x 2 x
1.5 -9.5
year
open balance
PV = FV/(1+r)^n DDB dep
WACC=Wd x rd x (1-t) + We x re =0.5*6%*0.6+0.5*10% = 0.068 straight line
return on debt = cost of debt closing
return on equity
D/E = 1/1
Wd = 1/2 = We IRR: tỉ suất hoàn vốn
NPV = sum(PV) = 2.84801012 Accept WACC: chi phí vốn
IRR > WACC --> accept
CAPM: Capital-Asset Pricing Model
re = rf + beta x (rm - rf) 0 = -41 + 8.25/(1+x)^1 + 9.225/(1+x)^2 + 10
re: return on equity/cost of equity x = 0.093
rf: risk-free rate IRR > WACC -> accept
rm: market return
PI: profitable =
g balance in 6 years. After 4 years, they can be sold for $3 million. Dep rate 33.3%
1.069464 accept
non-discounted Pay Back Period 3.519189 years
discounted PBP 3.854565 years
clining method
on rate = 1/n x 2 x 100 = 1/4 x 2 x 100 = 50%
40%
1 2 3 4
30 18 10.8
12 7.2 4.32
7.5 6 5.4 5.4
18 10.8
IRR: 0 =
CC --> accept
.25/(1+x)^1 + 9.225/(1+x)^2 + 10.2975/(1+x)^3 + 25.4773/(1+x)^4
CC -> accept
>1 -> accept
