Question 1:
PAT is a panel company which is showing the earnings after tax which is $75,000 and it has the negative present value $58,750. It means that the investment amount will not generate the future cash flows, so the investment in panel industry is useless as it has no worth according to calculations. See below for the earnings and present value.
|
Income Statement |
|
| Revenue | $ 150,000 |
| Cost | $ 25,000 |
| EBT | $ 125,000 |
| Tax | $ 50,000 |
| EAT | $ 75,000 |
|
Cash Flows |
|
| EAT | $ 75,000 |
| Depreciation | $ 200 |
| FCF | $ 75,200 |
| Present Value of FCF | $ (58,750) |
Question 2:
|
Cash Flows |
|
| EAT | $ 60,000 |
| Depreciation | $ 200 |
| FCF | $ 60,200 |
| Present Value of Interest Tax Shields | $ 125,000 |
| Annual Cash Flows | $ (64,800) |
This investment is not worthwhile as its net present value after incorporating debt is showing negative results; which means that by investing in this project the future cash flows will not generate returns on investment positively. Refer excel sheet of the calculation for the below table.
|
Income Statement |
|
| Revenue | $ 150,000 |
| Cost | $ 50,000 |
| EBT | $ 100,000 |
| Tax | $ 40,000 |
| EAT | $ 60,000 |
Question 3:
The investment in this industry is not optimal as this industry will generate the future cash flows after incurring cost for several years.
This industry has the potential to grow but the cost of capital is very high in the initial stage. To conclude, investment should be made where the return of investment is relatively high than panel industry. Please refer the excel sheet for the calculation.
|
Income Statement |
|
| Revenue | $ 150,000 |
| Cost | $ 42,000 |
| EBT | $ 108,000 |
| Tax | $ 43,200 |
| EAT | $ 64,800 |
|
Cash Flows |
|
| EAT | $ 64,800 |
| Depreciation | $ 200 |
| FCF | $ 65,000 |
| Present Value of Interest Tax Shields | $ 125,000 |
| Annual Cash Flows | $ (60,000) |
........................
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