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 the 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

The free cash flow in year 0 In Millions Cost to build the factory -$230.00 Cash flow at Year 0 -$230.00 The free cash flow in year 1 In Millions Investment in Inventory -$13.00 Cash flow at Year 1 -$13.00 Annual depreciation in Year 2 = Cost / useful life = $230 million / 10 years = $23 million The free cash flow in year 2 In Millions earnings before interest and taxes $34.00 Tax on EBIT at 21% -$7.14 Depreciation tax shield [$23 million * 21%] $4.83 Cash flow at Year 2 $31.69 The free cash flow in year 11 In Millions earnings before interest and taxes $34.00 Tax on EBIT at 21% -$7.14 Depreciation tax shield [$23 million * 21%] $4.83 Cash flow at Year 11 $31.69 Calculation of NPV of the project Year Cash flow (in millions) Discount factor @ 6% Present Value (in millions) 0 -$230.00 1 -$230.00 1 -$13.00 0.943396 -$12.26 2 $31.69 0.889996 $28.20 3 $31.69 0.839619 $26.61 4 $31.69 0.792094 $25.10 5 $31.69 0.747258 $23.68 6 $31.69 0.704961 $22.34 7 $31.69 0.665057 $21.08 8 $31.69 0.627412 $19.88 9 $31.69 0.591898 $18.76 10 $31.69 0.558395 $17.70 11 $31.69 0.526788 $16.69 NPV of the project -$22.23