Beats wants to build a new factory to produce its headphones

Beats wants to build a new factory to produce its headphones. It will cost $230 million initially to build the factory over the course of 12 months, which will be worthless after 10 years. The factory will be depreciated linearly to $0 over 10 years. Beats already owns the land on which the factory will be built. The land is currently worth $10 million and was purchased for $2 million eight years ago. After completion of the factory at the end of year 1, Beats expects earnings before interest and taxes (EBIT) of $34 million each year for 10 years. The company also has to add inventory (components) worth $13 million just before operation starts at the end of the first year. Beat\'s marginal tax rate is 21% and its cost of capital is 6%.

What is the free cash flow in year 0 (in $ million)?

What is the free cash flow in year 1 (in $ million)?

What is the annual depreciation in year 2 (in $ million)?

What is the free cash flow in year 2 (in $ million)?

What is the free cash flow in year 11 (in $ million)?

What is the NPV of this project (in $ million)?

Solution

1.What is the free cash flow in year 0 (in $ million)?

Answer) Net Cash Out flow of 230 million

2.What is the free cash flow in year 1 (in $ million)?

Answer) Cash Inflow of $36.86 Million.

What is the annual depreciation in year 2 (in $ million)?

Answer) $230 Million/10 years = $23 Million.

What is the free cash flow in year 2 (in $ million)?

Answer) Cash Inflow of $49.86 Million.

What is the free cash flow in year 11 (in $ million)?

There will be no Cash flows at the end of 11^th year.

= (49.86/.06) x 0.943396

=

What is the NPV of this project (in $ million)?

Answer) NPV is $108.3 Million

Working Notes:

($ in Millions)