Introduction to Corporate Finance

PArT 3: CAPITAL BUDGETING

a Calculate the cash flows generated by Fusion as a stand-alone entity in each year from

2014–2018.

b Assume that by 2018, Fusion reaches a ‘steady state’, which means that its cash flows will grow

by 5% per year in perpetuity. If Fusion discounts cash flows at 15%, what is the present value at

the end of 2018 of all cash flows that Fusion will generate from 2019 forward?

c Calculate the present value, in 2013, of Fusion’s cash flows from 2014 forward. What does this

NPV represent?

d Suppose TGI acquires Fusion. Recalculate Fusion’s cash flows from 2014 to 2018, making all

the changes previously described in items 1–4 and 6.

e Assume that after 2018, Fusion’s cash flows will grow at a steady 5% per year. Calculate the

present value of these cash flows, at 2018, if the discount rate is 15%.

f Ignoring item 5 in the list of changes, what is the PV, in 2013, of Fusion’s cash flows from 2014

forward? Use a discount rate of 15%.

g Finally, calculate the NPV of TGI’s investment to integrate its technology with Fusion’s.

Considering this in combination with your answer to part (f), what is the maximum price that

TGI should pay for Fusion? Assume a discount rate of 15%.

P10-16 A project generates the following sequence of cash flows over six years:

Year Cash flow ($ in millions)

0 –59.00

1 4.00

2 5.00

3 6.00

4 7.33

5 8.00

6 8.25

a Calculate the NPV over the six years. The discount rate is 11%.

b This project does not end after the sixth year, but instead will generate cash flows far into the

future. Estimate the terminal value, assuming that cash flows after year 6 will continue at $8.25

million per year in perpetuity, and then recalculate the investment’s NPV.

c Calculate the terminal value, assuming that cash flows after the sixth year grow at 2% annually

in perpetuity, and then recalculate the NPV.

d Using market multiples, calculate the terminal value by estimating the project’s market value

at the end of year 6. Specifically, calculate the terminal value under the assumption that at the

end of year 6, the project’s market value will be 10 times greater than its most recent annual

cash flow. Recalculate the NPV.

SPECIAL PROBLEMS IN CAPITAL BUDGETING

P10-17 You have a $10 million capital budget and must make the decision about which investments

your company should accept for the coming year. Projects 1, 2 and 3 are mutually exclusive, and

Project 4 is independent of all three. The company’s cost of capital is 12%.

Project 1 Project 2 Project 3 Project 4

Initial cash outflow –$4,000,000 –$5,000,000 –$10,000,000 –$5,000,000

Year 1 cash inflow 1,000,000 2,000,000 4,000,000 2,700,000

Year 2 cash inflow 2,000,000 3,000,000 6,000,000 2,700,000

Year 3 cash inflow 3,000,000 3,000,000 5,000,000 2,700,000