QUESTION
| WONDER KIDZ WORKSHEET | ||||||||
| 1. Calculate the overall cost of capital of the project used for analyzing the cash profitability. | ||||||||
| Cost of equity = | 0 | Bansal has invested no funds of his own. | ||||||
| Cost of debt = i(1-t) | i=average interest, t=tax rate | |||||||
| Calculate: | ||||||||
| Cost of debt %: | ||||||||
| Over all weighted cost of capital: | ||||||||
| 2. As a fiscal consultant, do you think the project is financially viable? To support your answer, calculate the net present value (NPV). | ||||||||
| Years | Cash Profitability (₹) (from case Exhibit 3) | PVF | PV (₹) | |||||
| 1 | ||||||||
| 2 | ||||||||
| 3 | ||||||||
| 4 | ||||||||
| 5 | ||||||||
| Total PV: | ||||||||
| Less | ₹ 624,450.00 | |||||||
| NPV | ||||||||
| 3. Evaluate the project using other capital budgeting techniques such as payback period, discounted payback period, internal rate of return (IRR), and profitability index (PI). Recommend a final decision regarding investment. | ||||||||
| Non-Discounted Payback Period: | ||||||||
| (Look at when the initial investment will be recovered compared to the target start-up period of business.) | ||||||||
| Discounted Payback Period: | ||||||||
| (Look at the time of the cash outflow of the business and the overall cost of capital) | ||||||||
| Internal Rate of Return: | ||||||||
| (Remember, IRR is defined ad th erate in which the NPV of the project equals zero. An Irr of more than the cost of capital suggests the project is financially feasible, whereas an IRR of less then the cost of capital indicates the project may not be able to sufficiently generate cash flows and may lead to a loss.) | ||||||||
| Profitability Index: | ||||||||
| (PI = PV of Future Cash Flows / Initial Investment | ||||||||
| 4. What will be the changes in profitability and NPV if the franchisee offers a discount on the fee? Perform a sensitivity analysis and identify the maximum discount that can be offered. (Note: I put the analysis in the sheet for you. Please try different amounts for the discount. At what point does the project become unprofitable?) | ||||||||
| Year 1 | Year 2 | Year 3 | ||||||
| Total Students | 35 | 50 | 80 | |||||
| New Enrollments | 35 | 25 | 40 | |||||
| Old Enrollments | 0 | 25 | 40 | |||||
| Fees collected from new students (1 time and annual) Note: 1,000 discount in year 1 and 500 discount in yYear 2—experiment with different discounts) | 17,500 | 18,000 | 18,500 | |||||
| Fees collected from old studnets (annual) | 0 | 15,500 | 16,000 | |||||
| Total Fees collected (without caution money) | 612,500 | 837,500 | 1,380,000 | |||||
| Total Expenses from Exhibit 3 | 516,000 | 675,000 | 966,000 | |||||
| Operational Profit | 96,500 | 162,500 | 414,000 | |||||
| Add: Interest on caution money at 8% | 4,200 | 6,000 | 9,600 | |||||
| Less: Interest on capital at 15% | 90,000 | 90,000 | 90,000 | |||||
| Earnings before tax | 10,700 | 78,500 | 333,600 | |||||
| Less 20% Tax rate | 2,140 | 15,700 | 66,720 | |||||
| Earnings after cash (Cash Flows) | 8,560 | 62,800 | 266,880 | |||||
| 5. Critically evaluate the proposed profitability projections and comment on them. | ||||||||
| (Use the answers to questions 1-4 and your knowledge of corporate /non-profit finance to explain if Bansal should or should not go forward with the project.) | ||||||||
ANSWER
| WONDER KIDZ WORKSHEET | ||||||||
| 1. Calculate the overall cost of capital of the project used for analyzing the cash profitability. | ||||||||
| Cost of equity = | 0 | Bansal has invested no funds of his own. | ||||||
| Cost of debt = i(1-t) | 12.00% | i=average interest, t=tax rate | ||||||
| Calculate: | ||||||||
| Cost of debt %: | 12.00% | |||||||
| Over all weighted cost of capital: | 12.00% | |||||||
| 2. As a fiscal consultant, do you think the project is financially viable? To support your answer, calculate the net present value (NPV). | ||||||||
| Years | Cash Profitability (₹) (from case Exhibit 3) | PVF | PV (₹) | |||||
| 1 | 44960 | 0.892857142857143 | ₹ 40,142.86 | |||||
| 2 | 94800 | 0.79719387755102 | ₹ 75,573.98 | |||||
| 3 | 286080 | 0.711780247813411 | ₹ 203,626.09 | |||||
| 4 | 286080 | 0.635518078404831 | ₹ 181,809.01 | |||||
| 5 | 286080 | 0.567426855718599 | ₹ 162,329.47 | |||||
| Total PV: | ₹ 663,481.42 | |||||||
| Less | ₹ 624,450.00 | |||||||
| NPV | ₹ 39,031.42 | |||||||
| 3. Evaluate the project using other capital budgeting techniques such as payback period, discounted payback period, internal rate of return (IRR), and profitability index (PI). Recommend a final decision regarding investment. | ||||||||
| Non-Discounted Payback Period: | ||||||||
| (Look at when the initial investment will be recovered compared to the target start-up period of business.) | ||||||||
| 3.69 | ||||||||
| Discounted Payback Period: | ||||||||
| (Look at the time of the cash outflow of the business and the overall cost of capital) | ||||||||
| 4.76 | ||||||||
| Internal Rate of Return: | ||||||||
| (Remember, IRR is defined ad th erate in which the NPV of the project equals zero. An Irr of more than the cost of capital suggests the project is financially feasible, whereas an IRR of less then the cost of capital indicates the project may not be able to sufficiently generate cash flows and may lead to a loss.) | ||||||||
| 13.95% | ||||||||
| Profitability Index: | ||||||||
| (PI = PV of Future Cash Flows / Initial Investment | ||||||||
| 1.06 | ||||||||
| 4. What will be the changes in profitability and NPV if the franchisee offers a discount on the fee? Perform a sensitivity analysis and identify the maximum discount that can be offered. (Note: I put the analysis in the sheet for you. Please try different amounts for the discount. At what point does the project become unprofitable?) | ||||||||
| Year 1 | Year 2 | Year 3 | ||||||
| Total Students | 35 | 50 | 80 | |||||
| New Enrollments | 35 | 25 | 40 | |||||
| Old Enrollments | 0 | 25 | 40 | |||||
| Fees collected from new students (1 time and annual) Note: 1,000 discount in year 1 and 500 discount in yYear 2—experiment with different discounts) | 17,500 | 18,000 | 18,500 | |||||
| Fees collected from old studnets (annual) | 0 | 15,500 | 16,000 | |||||
| Total Fees collected (without caution money) | 612,500 | 837,500 | 1,380,000 | |||||
| Total Expenses from Exhibit 3 | 516,000 | 675,000 | 966,000 | |||||
| Operational Profit | 96,500 | 162,500 | 414,000 | |||||
| Add: Interest on caution money at 8% | 4,200 | 6,000 | 9,600 | |||||
| Less: Interest on capital at 15% | 90,000 | 90,000 | 90,000 | |||||
| Earnings before tax | 10,700 | 78,500 | 333,600 | |||||
| Less 20% Tax rate | 2,140 | 15,700 | 66,720 | |||||
| Earnings after cash (Cash Flows) | 8,560 | 62,800 | 266,880 | |||||
| 5. Critically evaluate the proposed profitability projections and comment on them. | ||||||||
| (Use the answers to questions 1-4 and your knowledge of corporate /non-profit finance to explain if Bansal should or should not go forward with the project.) | ||||||||
| There are few problem with the analysis done above. The discounting rate is based on only debt whereas for the purpose cash flow calculation we are taking into the account the interest which should not be taken. Again we are ignoring depreciation which in itself is wrong because depreciation will give us the tax benefit. Also, Bansal would like the school to run for more than 5 years, we should have taken a terminal value. All of the above factors would increase the NPV. Also, in sensitivity analysis the discount will increase the number of student which hasn’t been taken into consideration. Given all the above factors, Bansal should definitely go ahead with the idea of school. | ||||||||
| Year 1 | Year 2 | Year 3 | Year 3 | Year 3 | |
| Total Students | 35 | 50 | 80 | 80 | 80 |
| New Enrollments | 35 | 25 | 40 | 40 | 40 |
| Old Enrollments | 0 | 25 | 40 | 40 | 40 |
| Fees collected from new students | 18,800 | 18,800 | 18,800 | 18,800 | 18,800 |
| Fees collected from old studnets (annual) | 0 | 16,300 | 16,300 | 16,300 | 16,300 |
| Total Fees collected (without caution money) | 658,000 | 877,500 | 1,404,000 | 1,404,000 | 1,404,000 |
| Total Expenses from Exhibit 3 | 516,000 | 675,000 | 966,000 | 966,000 | 966,000 |
| Operational Profit | 142,000 | 202,500 | 438,000 | 438,000 | 438,000 |
| Add: Interest on caution money at 8% | 4,200 | 6,000 | 9,600 | 9,600 | 9,600 |
| Less: Interest on capital at 15% | 90,000 | 90,000 | 90,000 | 90,000 | 90,000 |
| Earnings before tax | 56,200 | 118,500 | 357,600 | 357,600 | 357,600 |
| Less 20% Tax rate | 11,240 | 23,700 | 71,520 | 71,520 | 71,520 |
| Earnings after cash (Cash Flows) | 44,960 | 94,800 | 286,080 | 286,080 | 286,080 |
| NPV of the Future Earnings | ₹ 663,481.42 | ||||
| Initial Investment | ₹ 624,450.00 | ||||
| NPV | ₹ 39,031.42 |
| 18,800 |
| 16,300 |
| Old Enrollment Fees | |||||||||||
| ₹ 39,031 | ₹ 12,800 | ₹ 13,300 | ₹ 13,800 | ₹ 14,300 | ₹ 14,800 | ₹ 15,300 | ₹ 15,800 | ₹ 16,300 | ₹ 16,800 | ₹ 17,300 | |
| New Enrollment Fees | ₹ 15,300 | ||||||||||
| ₹ 15,800 | |||||||||||
| ₹ 16,300 | |||||||||||
| ₹ 16,800 | |||||||||||
| ₹ 17,300 | |||||||||||
| ₹ 17,800 | |||||||||||
| ₹ 18,300 | |||||||||||
| ₹ 18,800 | |||||||||||
| ₹ 19,300 | |||||||||||
| ₹ 19,800 | |||||||||||
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