Mini-case on NPV, IRR, Value Creation and Economic Profit:

Facts:
1. Initial investment in fixed assets $850 which includes $50 for land (not subject to depreciation)
2. $800 fixed assets will be depreciated over 5 years using straight line depreciation: $160 each year
3. Cost of Goods sold 60% of sales
4. Other operating expenses fixed $50 per year
5. Tax Rate 40%
6. Net Working Capital 20% of sales
7. Working capital will be fully recovered at year 5
8. The fixed assets including land will be sold for $320 (after taxes) at the end of year 5.
9. Sales in year 1 are expected to be $1,000 and projected to increase 3% per year thereafter
10. Cost of capital is 15%

Assignment:
1. Compute Net Present Value (NPV) and Internal Rate of Return using discounted cash flow method.
2. Compute annual economic profit and NPV.
3. Compute Value Creation for the project showing that if accepted cash flows will provide (a) an
annual rate of return of 15%, (b) return of capital invested, and (c) value creation equal to NPV.

Suren Mansinghka: NPV/Eco Profit/Value Creation Case

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Part A: Calculation of NPV and IRR:

Table 1: Projected Income Statement
1
1,000
600
50
350
160
190
76
114

1. Sales
2. Cost of Goods Sold
3. Operating Expenses
4. EBITDA (1-2-3)
5. Depreciation
6. EBIT (4-5)
7. Taxes @40% of 6
8. NOPAT (6-7)

2
1,030
618
50
362
160
202
81
121

3
1,061
637
50
374
160
214
86
129

4
1,093
656
50
387
160
227
91
136

5
1,126
675
50
400
160
240
96
144

Comments
3% growth
60% of Sales
Constant
Straight line

Table 2: Projected Balance Sheet

0
1. Working Capital
2. Net Fixed Assets
3. Land
4. Invested Capital

800
50
850

1
200
640
50
890

2
206
480
50
736

3
212
320
50
582

4
219
160
50
429

5
225
0
50
275

Comments
20% of Sales
Depreciated Value
Given

Table 3: Projected Cash Flows

0
1. NOPAT
2. Depreciation
3. Operating CF (1+2)
4. Working Capital
5. Fixed Assets
6. Sale of Fixed Assets
7. Recovery of Working Capital
8. Investment Cash Flow (4+5+6+7)
9. Project Cash Flow (3+8)

1
114
160
274
(200)

2
121
160
281
(6)

3
129
160
289
(6)

4
136
160
296
(7)

(200)
74

(6)
275

(6)
283

(7)
289

(850)

(850)
(850)

5
144
160
304
(6)

Comments
Table 1
Table 1

Table 2
Table 2
320 Given
225 Given
539
843

A: NPV @ 15% = $193 and IRR = 21.74%

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Part B: Calculation of Economic Profit:

Table 4: Economic Profit: Alternative 1
1. Invested Capital
2. Inv. Capital (t-1)
3. Capital Charge
4. NOPAT
5. Economic Profit

0
850

1
890
850
128
114
(14)

2
736
890
134
121
(13)

3
582
736
110
129
19

4
429
582
87
136
49

5
275
429
64
144
80

Comments
Table 2
15% of line 2
Table 1
(line 4-3)

Table 5: Economic Profit: Alternative 2

1
1. Inv. Capital (t-1)
2. NOPAT
3. ROIC
4. Cost of Capital
5. Economic Profit

850
114
13.41%
15.00%
(14)

890
121
13.60%
15.00%
(13)

3
736
129
17.53%
15.00%
19

4
582
136
23.37%
15.00%
49

5
429
144
33.57%
15.00%
80

Comments
Table 4
Table 1
Line 2/Line 1
Given
(Line 3- Line 4)x Line 1

Table 6: NPV Using Economic Profit

1. Economic Profit
2. Profits on Sale of Invested capital
3. Total Economic Profit (line 1+2)
4. PV of Economic Profit @ 15%

1
(14)

2
(13)

(14)
$193

(13)

19

49

19

49

Comments
80 Table 4 or 5
270 See footnotes below
350

1. Resale Value of Invested Capital: $545 (Line 6 + Line 7 from Table 3)

2. Book value of invested capital (t=5) Table 2: $275
3. Profit on Sale = Item 1 item 2 = 545-275 = 270

Suren Mansinghka: NPV/Eco Profit/Value Creation Case

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Part C: Calculation of Value Creation: Using NPV

Table 7: Value Creation & Return on and Return of Capital
Time Cash Flow1 Return @15%
Principal
Balance
Investment Ending Balance
(1)
(2)
(3) = 7t-1 x 15% (4) = 2-3
(5) = 7t-1 + 4 (6)
(7) = 5 + 6
0
-850
-850.00
1
274
127.50
146.50
-703.50
-200.0
-903.50
2
281
135.50
145.50
-758.00
-6.00
-764.00
3
289
114.60
174.40
-589.60
-6.00
-595.60
4
296
89.34
206.66
-388.96
-7.00
-395.96
2
5
304
59.60
244.40
-151.56
539.00
387.44
PV of $387.44 @15% for 5 years = 387.44 x 0.4972 193 (Same as NPV)
1. Cash flows shown for years 1 through 5 are Operating Cash flows from Table 3 as
investment cash flows are shown separately in column 6.
2. The figure is derived by deducting from $545 (recovery of working capital plus sale of fixed
assets) new investment in working capital of $6. See table 3 for details

Suren Mansinghka: NPV/Eco Profit/Value Creation Case

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