# Problem 23 Bauer Industries case solution

Problem 23 Bauer Industries is an automobile manufacturer. Management is currently evaluating a proposal to build a plant that will manufacture lightweight trucks. Bauer plans to use a cost of capital of 12% to evaluate this project. Based on extensive research, it has prepared the following incremental free cash flow projections (in millions of dollars): Year 0 Years 1-9 Year 10 Revenues 100.0 100.0 – Manufacturing expenses (other than depreciation) -35.0 -35.0 – Marketing expenses -10.0 -10.0 – Depreciation -15.0 -15.0 = EBIT 40.0 40.0 – Taxes (35%) -14.0 -14.0 = Unlevered net income 26.0 26.0 + Depreciation + 15.0 + 15.0 – Additions to working capital – 5.0 – 5.0 – Capital expenditures – 150.0 + Continuation value + 12.0 = Free cash flow – 150.0 36.0 48.0 a. For this base-case scenario, what is the NPV of the plant to manufacture lightweight trucks? b. Based on input from the marketing department, Bauer is uncertain about its revenue forecast. In particular, management would like to examine the sensitivity of the NPV to the revenue assumptions. What is the NPV of this project if revenues are 10% higher than forecast? What is the NPV if revenues are 10% lower than forecast? c. Rather than assuming that cash flows for this project are constant, management would like to explore the sensitivity of its analysis to possible growth in revenues and operating expenses. Specifically, management would like to assume that revenues, manufacturing expenses, and marketing expenses are as given in the table for year 1 and grow by 2% per year every year starting in year 2. Management also plans to assume that the initial capital expenditures (and therefore depreciation), additions to working capital, and continuation value remain as initially specified in the table. What is the NPV of this project under these alternative assumptions? How does the NPV change if the revenues and operating expenses grow by 5% per year rather than by 2%? d. To examine the sensitivity of this project to the discount rate, management would like to compute the NPV for different discount rates. Create a graph, with the discount rate on the x-axis and the NPV on the y-axis, for discount rates ranging from 5% to 30%. For what ranges of discount rates does the project have a positive NPV?

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# 23

xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxProblem 23 | |||

xxxxx xxxxxxxxxx is an xxxxxxxxxx xxxxxxxxxxxxx xxxxxxxxxx xx xxxxxxxxx xxxxxxxxxx x xxxxxxxx xx xxxxx x plant that will xxxxxxxxxxx lightweight xxxxxxx xxxxx xxxxx xx use x xxxx xx xxxxxxx xx 12% xx evaluate this project. Based on xxxxxxxxx xxxxxxxxx xx has xxxxxxxx xxx following incremental xxxx xxxx flow xxxxxxxxxxx xxx xxxxxxxx xx dollars): | |||

xxxx x | Years xxx | xxxx xx | |

Revenues | 100.0 | xxxxx | |

– Manufacturing expenses | |||

(other xxxx xxxxxxxxxxxxx | -35.0 | xxxxx | |

– xxxxxxxxx expenses | xxxxx | -10.0 | |

– Depreciation | -15.0 | -15.0 | |

x EBIT | xxxx | xxxx | |

– xxxxx xxxxx | xxxxx | -14.0 | |

x xxxxxxxxx xxx income | 26.0 | 26.0 | |

x Depreciation | + xxxx | + xxxx | |

– Additions to xxxxxxx xxxxxxx | – xxx | – xxx | |

– Capital xxxxxxxxxxxx | – xxxxx | ||

x xxxxxxxxxxxx xxxxx | x 12.0 | ||

= xxxx xxxx flow | – 150.0 | xxxx | xxxx |

a. | For this base-case scenario, xxxx is xxx NPV of the xxxxx xx xxxxxxxxxxx xxxxxxxxxxx xxxxxxx | ||

xx | Based xx input from xxx marketing department, Bauer xx |

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## Problem 23 Bauer Industries case solution

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# 8-23

xxxxxxxxxxxxxxxxxxxProblem xxxx | |||

xxxxx xxxxxxxxxx is an xxxxxxxxxx manufacturer. xxxxxxxxxx xx xxxxxxxxx xxxxxxxxxx a xxxxxxxx to build a xxxxx xxxx will xxxxxxxxxxx lightweight xxxxxxx Bauer plans xx xxx x cost xx capital xx xxx to xxxxxxxx xxxx project. xxxxx xx xxxxxxxxx research, xx has xxxxxxxx xxx xxxxxxxxx incremental free cash xxxx projections (in xxxxxxxx of xxxxxxxxx | |||

xxxx 0 | xxxxx xxx | xxxx 10 | |

xxxxxxxx | xxxxx | 100.0 | |

– xxxxxxxxxxxxx expenses | |||

(other than depreciation) | -35.0 | -35.0 | |

– Marketing expenses | xxxxx | -10.0 | |

– xxxxxxxxxxxx | xxxxx | -15.0 | |

x xxxx | 40.0 | 40.0 | |

– xxxxx xxxxx | -14.0 | -14.0 | |

x xxxxxxxxx net income | 26.0 | xxxx | |

x xxxxxxxxxxxx | xxxx | 15.0 | |

– xxxxxxxxx xx working xxxxxxx | -5.0 | xxxx | |

– xxxxxxx expenditures | xxxxxx | ||

x xxxxxxxxxxxx value | xxxx | ||

= Free cash xxxx | xxxxxx | xxxx | 48.0 |

xx | xxx xxxx base-case xxxxxxxxx xxxx is xxx xxx xx xxx xxxxx to xxxxxxxxxxx lightweight trucks? | ||

Answer: | For the xxxxxxxxxx the xxx xx | 57.27 | xxxxxxx |

xx | Based on input from the xxxxxxxxx xxxxxxxxxxx Bauer is |

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