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Worldwide Trousers, Inc. Cash Flows: Adjusted Present Value Example

Worldwide Trousers is considering a 5-year project with an initial investment of $5.1 million and annual pre-tax earnings of $1.5 million for years 1-4. To calculate the project's adjusted present value, the analysis first determines the unlevered cash flows of $990,000 per year and discounts them at 18% to get -$1.49 million. It then calculates the net present value of tax shields from interest and depreciation totaling $1.97 million. Adding these amounts gives the project an adjusted present value of $473,637, indicating it should be accepted.

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Nguyễn Gia Phương Anh
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35 views

Worldwide Trousers, Inc. Cash Flows: Adjusted Present Value Example

Worldwide Trousers is considering a 5-year project with an initial investment of $5.1 million and annual pre-tax earnings of $1.5 million for years 1-4. To calculate the project's adjusted present value, the analysis first determines the unlevered cash flows of $990,000 per year and discounts them at 18% to get -$1.49 million. It then calculates the net present value of tax shields from interest and depreciation totaling $1.97 million. Adding these amounts gives the project an adjusted present value of $473,637, indicating it should be accepted.

Uploaded by

Nguyễn Gia Phương Anh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as XLSX, PDF, TXT or read online on Scribd
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Adjusted Present Value Example

Worldwide Trousers, Inc. Cash flows


Cost (5,000,000) Inital investmen (5,100,000)
Year 5
NWC (100,000) Terminal cash flow (4)

Pretax earnings (1-4) 1,500,000 SV (after tax) 330,000 at 18%

Salvage value 500,000 Recovery NWC 100,000 at 4%


Debt 3,000,000
Cost of debt 12.5% Annual OCF (1-4)
Cost of capital (all eq 18% Unlevered CF 990,000
Tc 34%
Risk free (Rf) 4%
Depreciation 1,000,000

Step 1: Calculate the value of unlevered project (VU)


Year 0 1 2 3 4
FCF (5,100,000) 990,000 990,000 990,000 990,000

Unlevered cost of capital 18%


Value of unlevered project (1,576,148) 82,193
(1,493,955)

Step 2: Calculate the net value of debt financing (PVF)


Debt amount 3,000,000
Cost of debt 12.5%
Interest rate 4%
Tax rate 34%
PVIFA(12.5%,5) 3.5606
PVIFA(4%,5) 4.4518
PV of interest tax shield 453,972
PV of depreciation tax shield 1,513,620
NPVF 1,967,592

Step 3: Find the adjusted present value of the project (APV)


Adjusted present value of project 473,637

𝐴𝑃𝑉=−𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣. + 〖𝑃𝑉〗 _█(


〖𝑃𝑉〗 _█(𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 @𝑡𝑎𝑥 𝑠ℎ
5
1,320,000
100,000
+ 〖𝑃𝑉〗 _█(𝑢𝑛𝑙𝑒𝑣𝑒𝑟𝑒𝑑 @𝐶𝐹)+
𝑎𝑡𝑖𝑜𝑛 @𝑡𝑎𝑥 𝑠ℎ𝑖𝑒𝑙𝑑)+ 〖𝑃𝑉〗 _█(𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 @𝑡𝑎𝑥 𝑠ℎ𝑖𝑒𝑙𝑑)

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