Part 2: Valuation For the following questions, please use a value of 6.05% for the pre-tax WACC and 6.00% for the after-tax WACC (i.e. ignore the values you’ve calculated in part 1). Question 5 The...

Basic Finance, FCF, NPV and WACC discussion, more in file


Part 2: Valuation For the following questions, please use a value of 6.05% for the pre-tax WACC and 6.00% for the after-tax WACC (i.e. ignore the values you’ve calculated in part 1). Question 5 The CEO of Amazon is currently (end of 2020) considering investing in a new project to further expand to Asia. The project will last for 6 years. The development of the project will take one year. It is expected that the project will raise the annual sales by $450mln in the first year (at the end of 2021, t = 1) and that these additional sales will grow by 7% annually for two years ( t = 2 and 3). Subsequently, the sales are forecasted to grow by 8% for the next two years (t = 4 and 5) and will then remain stable for one more year (t = 6). Assume no further impact from year 7 onwards. To develop the project, an initial R&D investment of $450mln needs to be made and $200mln worth of equipment needs to be purchased (t = 0). Based on the accounting rules, the R&D investments needs to be expensed directly. Additionally, $145mln worth of equipment needs to be bought one year from now (t = 1). Both investments in equipment are depreciated using the straight-line method in 5 years to a salvage value of $0. The cost of goods sold is expected to be 40% of the sales and the operating expenses (excl. depreciation) are estimated at $60mln per year (i.e. constant throughout the project). Accounts receivable are assessed to be 21% of the sales, whereas the accounts payable and inventory are 17% and 15% of the cost of goods sold, respectively. Assume no cash requirements are needed for this project and that the investment in NWC is not recovered at the end of the project. The corporate tax rate applicable for this project equals 21%. Assume Amazon is not allowed to carry forward or carry back losses so losses will trigger positive cash flows due to a reduction in taxes. · a)  What are the Free Cash Flows for this new project? Make a table in which you present your answers. Include the formula’s used. · b)  What assumptions are needed to use WACC as a discount rate to calculate the value of the project? · c)  What is the NPV of the project using the WACC method? Question 6 The management of Amazon decides to invest in the expansion to Asia as described in Question 5. Amazon however decides to change the capital structure used for the project so that it has a constant debt capacity of $300mln during the life of the project. Use a cost of debt of 5% in this exercise. What is the NPV of the project in this situation according to the APV method? Assume tax benefits have the same risk as the underlying debt. Why is this answer different compared to the WACC method?