Question

The firm Gelati-Banking (GB) is considering a project with the following characteristics. Sales will be $100 MM for sure in the first year and grow 10% in the second year; thereafter, the long term growth rate is 3%. Gross Profit Margin (Gross Profit over Sales) will be 20%. Depreciation will be $10 MM each year for the next two years. Working Capital held for the project will have to be 10% of sales. Additional CAPX each year will be $11MM in year 1 and $12 MM in year 2. All cash flows defined here are deterministic and will go on indefinitely. Interest rates are as follows: 3-month t-bill is 3%, the 2 year treasury is 4% and the long bond (30-year) is trading at 5% per year. The Corporate Tax Rate is 40%. What would the investment need to be for this project to be breakeven (ignoring depreciation effects of the investment)

Answer 1

Answer:

Investment needed for breakeven is 784.48 MM

Explanation:

Working is attached with this answer in PDF file, please find it.

The project will be at breakeven when NPV will be equal to 0

NPV = -Investment + Present value of year 1 cash flows + Present value of year 2 cash flows + Present value of year 3 and onwards cash flows

0 = - investment + 5/1.03 + 14.2/(1.04)2 + 15.326 / (0.05 - 0.03)

0 = -Investment + 4.854  + 13.129 + 766.500

Investment = 4.854  + 13.129 + 766.500

Investment = 784.483

 

(1.05)3

The investment will be less than $ 679.94 MM. At time 0 , the project will be at breakeven when the investment invested intially will be less than $ 669.94 MM.