XYZ Company has been offered a new contract to supply food and beverage to a large corporate customer EAT Company for a
Posted: Tue Jan 18, 2022 1:02 pm
XYZ Company has been offered a new contract to supply food and
beverage to a large
corporate customer EAT Company for a period of 5 years. It pays
Analytics Consultants
Company (ACC) $20,000 to conduct an analysis of the profitability
of the venture to
determine whether to take up the contract.
EAT Company will pay XYZ Company $1 million per year under the
contract.
According to ACC’s calculations, XYZ company would incur fixed
costs of $200,000
per annum, while variable costs will account for 30% of sales. XYZ
company will need
to invest in a new equipment which will cost $500,000. The
equipment will be
depreciated on a straight-line basis to zero over the 5-year life.
The equipment can be
sold for its book value at the end of the contract. The company
will need to increase net
working capital by $2 million. In addition, it plans to issue bonds
of $1 million for a 5-
year term at a coupon rate of 5% priced at par. The company has an
existing bank loan
of $2 million.
The tax rate is 30%. This new contract has the same risk as the
average risk of the
company.
The beta of the XYZ Company is 0.8. Current Treasury bills yield is
3%. The return on
the stock market is 10%. The Company has 1 million common shares
with a market price
of $3 per share.
a) what is the operating cash flow
b) Compute the cash flows from assets for the project.
c) Calculate the NPV of the project using a discount rate of 10%
and determine if
the project should be accepted. If the discount rate is not given,
recommend the
appropriate discount rate to use.
beverage to a large
corporate customer EAT Company for a period of 5 years. It pays
Analytics Consultants
Company (ACC) $20,000 to conduct an analysis of the profitability
of the venture to
determine whether to take up the contract.
EAT Company will pay XYZ Company $1 million per year under the
contract.
According to ACC’s calculations, XYZ company would incur fixed
costs of $200,000
per annum, while variable costs will account for 30% of sales. XYZ
company will need
to invest in a new equipment which will cost $500,000. The
equipment will be
depreciated on a straight-line basis to zero over the 5-year life.
The equipment can be
sold for its book value at the end of the contract. The company
will need to increase net
working capital by $2 million. In addition, it plans to issue bonds
of $1 million for a 5-
year term at a coupon rate of 5% priced at par. The company has an
existing bank loan
of $2 million.
The tax rate is 30%. This new contract has the same risk as the
average risk of the
company.
The beta of the XYZ Company is 0.8. Current Treasury bills yield is
3%. The return on
the stock market is 10%. The Company has 1 million common shares
with a market price
of $3 per share.
a) what is the operating cash flow
b) Compute the cash flows from assets for the project.
c) Calculate the NPV of the project using a discount rate of 10%
and determine if
the project should be accepted. If the discount rate is not given,
recommend the
appropriate discount rate to use.