DB#3 Sneaker 2013The objective of the Case Debriefings is

DB#3: Sneaker 2013
The objective of the Case Debriefings is to revisit the cases in
light of the class discussions and demonstrate your
comprehension of salient issues, frameworks used for analysis,
and the implications of the courses of action considered during
the case discussions.
For each case, you should briefly describe the context and the
problem, analytical tools used to address the problem, and
critical lessons learned. In your reflection essay, you are not
expected to replicate the solution. Your discussion should focus
on synthesis; you should emphasize what you learned and its
practical value.
You should use the following outline to structure your
debriefing and make sure that you address the issues outlined
above. You can use graphics, tables, and charts to make your
point.
Outline:
Case Context
Problem/Analytical Issues
Tools used
Critical lessons learned
Concluding Remarks
Your debriefing should be authentic and not exceed 2 pages
excluding charts and tables (12 pt characters) . You should
think carefully and write effectively communicating the most
critical takeaways from the case discussion. Please submit your
work in MS Word doc or docx format.

Accounting 2200 Professor
John Jastremski
Term Project Fall 2021
Warren Buffett and the Interpretation of Financial Statements
Determining if a Company Has a Durable Competitive
Advantage
Step 4: Template to Record Financial Statement Elements
Instructions: This document is in Word format (Office 2010; the
extension is *.docx). Download and open this file on your
desktop or laptop/tablet. Type your responses into the
appropriate cell in the table. Save the file (save it as a Word
document with the *.docx extension or as a PDF file), then
upload into Blackboard by the due date, 10/22/2021. DO NOT
UPLOAD PICTURES, SCREEN CAPTURES, JPG/JPEG, GIF,
etc.
Table 1. Student and company information.
Student name:
Name of company selected:
Ticker symbol:
Table 2. List of chapters and financial statement components
selected.
Chapter #
Indicate one:
Income Statement/Balance Sheet/ Cash flow Statement
Name of Financial Statement Component

Table 3. Method of how financial statements will be provided.
Indicate with an X below
Description of How Financial Stateme nts Will Be Provided:
I will upload a copy of the financial statements into Blackboard.
The financial statements must be a Word document, an Excel
file or a PDF)
I will provide a link to the financial statements I used to
perform my analysis. Copy and paste the link in the cell below.
BE SURE THE LINK WORKS. TEST IT – BETTER YET, GIVE
IT TO SOMEONE ELSE AND HAVE THEM TEST IT.
Link to financial statements:
Accounting 2200

Professor John Jastremski
Term Project
Fall 2021
Advantage
Step 4
:
Template to Record
Financial Statement Elements
Instructions: This
document
is
in
Word

format
(Office 2010; the extension is *.docx)
. Download
and
open this file
on your desktop or laptop/tablet
. Type your responses into the appropriate cell in the
table. Save the file
(
save it as a Word document with the *.docx extension
or as
a PDF file
),
then upload
into Blackboard by the
due date, 10/22/2021.
DO NO
T UPLOAD PICTURES, SCREEN CAPTURES, JP
G
/JPEG
,
GIF
, etc.
Table 1.
Stud
ent and company information
.
Student n

ame:
N
ame of c
ompany
selected
:
Ticker symbol
:
Table 2.
List of chapters
and financial statement components selected.
Chapter #
Indicate one:
Income
S
tatement/
B
alance Sheet/ Cas
h
flow Statement
Name of
F
inancial
S

tatement
C
omponent
Table 3.
Method of how financial statements will be provided.
Indicate with an
X below
Description of How Financial
S
t
atements
Will Be Provided:
I wil
l upload
a copy of

the financial statements into Blackboard.
The financial
statements must be
a
Word
document
,
an
Excel file
or a
PDF)
I will provide a link to the financial stateme
nts I used to perform my ana
lysis. Copy
and past
e the link
in the cell below. BE SURE THE LINK WORKS. TEST IT
–
BETTER
YET, GIVE IT TO SOMEONE ELSE AND HAVE THEM TEST
IT.
Link to financial
statem
ents:

Accounting 2200 Professor John Jastremski
Term Project Fall 2021
Advantage
Step 4: Template to Record Financial Statement Elements
Instructions: This document is in Word format (Office 2010; the
extension is *.docx). Download and
open this file on your desktop or laptop/tablet. Type your
responses into the appropriate cell in the
table. Save the file (save it as a Word document with the *.docx
extension or as a PDF file), then upload
into Blackboard by the due date, 10/22/2021. DO NOT
UPLOAD PICTURES, SCREEN CAPTURES, JPG/JPEG,
GIF, etc.
Table 1. Student and company information.
Student name:
Name of company
selected:
Ticker symbol:
Table 2. List of chapters and financial statement components
selected.
Chapter # Indicate one:
Income Statement/Balance Sheet/ Cash
flow Statement
Name of Financial Statement
Component

Table 3. Method of how financial statements will be provided.
Indicate with an
X below
Description of How Financial Statements Will Be Provided:
I will upload a copy of the financial statements into
Blackboard. The financial
statements must be a Word document, an Excel file or a PDF)
I will provide a link to the financial statements I used to
perform my analysis. Copy
and paste the link in the cell below. BE SURE THE LINK
WORKS. TEST IT – BETTER
YET, GIVE IT TO SOMEONE ELSE AND HAVE THEM TEST
IT.
Link to financial
statements:
Capital Budgeting
A Framework for Corporate Investments
Dr. C. Bulent Aybar
Professor of International Finance
1
Investment Analysis and Capital Budgeting
At the beginning of the course, I emphasized three pillars of
value creation:
Investment
Funding
Distribution
It is time to discuss what we mean by value creating investment.

Capital Budgeting is a framework we can use to discipline our
analysis to make consistent value creating investment decisions.
This framework requires us to determine project cash flows and
use a decision rule to determine if the project adds value to the
investor’s wealth.
© Dr. C. Bulent Aybar
Three Stages of Project Cash Flows
A typical investment project requires investment today or over a
period of time until the project becomes operational.
This is the investment stage where we incur sizable cash
outflows to acquire land, build a plant, to purchase equipment
and make working capital investments to be prepared for the
operations.
Once project is operational, it starts to generate revenues and
incur operating costs.
It is also highly plausible that the project may require new
working capital and fixed assed investments during the
operational period. This phase is referred to as operational
stage.
Three Stages of Project Cash Flows
While the companies are ongoing concerns, projects invested by
firms are considered to have limited economic life.
This fundamental assumption implicitly suggests that each
project is terminated at the end of its economically useful life.
Terminal stage involves liquidation of project fixed assets and
working capital, environmental clean up and other expenses and
may create tax liabilities or tax benefits.

Project Cash Flows & Decision Rules: Summary
Initial Investment
Operational Cash Flows
Terminal Cash Flows
(+) Land
(+) Plant
(+) Equipment +Installation
(+) Working Capital Investment
=Initial Outlay
+Revenues
-Operating Costs
-Taxes
+Depreciation
-Change in WCR
-CapEx
=FCFP
(+) Proceeds from liquidation
(-) Tax Liability /(+) Tax Credit
(+) CF from Recall of WC
(=)Terminal Cash Flows
Decision Rules
Net Present Value
Internal Rate of Return (IRR)
MIRR
Profitability Index

Payback Period
Discounted Payback Period
5
Three Stages of Project Cash Flows-Expansion Project
New England Casting Company is considering adding a new line
to its product mix, and the capital budgeting analysis is being
conducted by a group led by Nick Jordan.
The production line would be set up in unused space in New
England Casting's main plant.
The equipment’s invoice price would be approximately
$200,000; another $10,000 in shipping charges would be
required; and it would cost an additional $30,000 to install the
equipment.
The machinery has an economic life of 4 years, and New
England Casting has obtained a special tax ruling which places
the equipment in the MACRS 3-year class.
The equipment is expected to have a salvage value of $25,000
after 4 years of use.
The new line would generate incremental sales of 1,250 units
per year for four years at an incremental cost of $100 per unit in
the first year, excluding depreciation.

MACRS Depreciation Tables
Each unit can be sold for $200 in the first year. The sales price
and cost are expected to increase by 3% per year due to
inflation.
Initially, NEC invests $25,000 in WCR, but it projects the
firm’s net operating working capital to be 12% of sales
revenues during the operational period.
The firm’s tax rate is 21 percent, and its overall weighted
average cost of capital is 10 percent.
Should New England Casting Company go for the investment to
introduce new line of products?

Tasks
For the proposed expansion determine:
Initial investment.
Operating cash inflows
Terminal cash flow
Using the data developed at the stage A, apply decision rules to
make a recommendation to the management team.
Project Data and Assumptions
Equipment cost$200,000Shipping charge$10,000Installation
charge$30,000WCR Investment at T=0$25,000Economic
Life4Salvage/Liquidation Value$25,000 Tax Rate21%Cost of
Capital10%Units Sold1250Sales Price Per Unit$200 Incremental
Cost Per Unit$100 Net Working Capital (WCR)12%Inflation
rate3%
Initial Investment
The initial Outlay is composed of fallowing:
(+) Land
(+) Plant
(+) Equipment +Installation
(+) Working Capital Investment
=Initial Outlay
In our example, NEC uses an idle space with no alternative use
for its expansion project; therefore there are no land & plant

acquisition costs, but we need to account for equipment
installation and working capital investments.
Initial Investment
The initial Outlay for NEC expansion project is composed of
fallowing:
Equipment Cost 200,000 Shipping Charge 10,000
Installation Charge 30,000 Net Working Capital
Investment 25,000Initial Outlay 265,000
3 Year MACRS Scheme
MACRS-3 Percentage10.3320.4530.1540.07
MACRS-3 PercentageBasis DepreciationBook Value 10.33
240,000 79,200 160,800 20.45 240,000
108,000 52,800 30.15 240,000 36,000
16,800 40.07 240,000 16,800 -
Note that the depreciable base includes costs that make the asset
available for use such as installation and shipping costs.
We estimate the free cash flows to the project using the
following structure:
(+) Revenues
(-) Operating Costs

(-) Taxes
(+) Depreciation
(-) Change in WCR
(-) CapEx
(=) Free Cash Flows to Project
Year 0Year 1Year 2Year 3Year 4Units 1,250 1,250
1,250 1,250 Unit price200.00 206.00 212.18 218.55 Unit
cost100.00 103.00 106.09 109.27 Sales 250,000 257,500
265,225 273,188 Costs (125,000) (128,750) (132,613)
(136,591)Depreciation (79,200) (108,000) (36,000)
(16,800)EBIT 45,800 20,750 96,613 119,797
Taxes (21%) (9,618) (4,358) (20,289)
(25,157)NOPAT 36,182 16,393 76,324 94,639
Depreciation 79,200 108,000 36,000 16,800
WCR 25,000 30,000 30,900 31,827 32,783
Change in WCR (25,000)-5000-900-927-955.5Cap-ExFCFP
110,382 123,493 111,397 110,484
Terminal Cash Flows at Liquidation
The terminal cash flows of the project are composed of:
(+) Proceeds from liquidation
(-) Tax liablity /(+) Tax Credit
(+) CF from Recall of WC
(=)Terminal Cash Flows

Terminal Cash Flows at Liquidation
The terminal cash flows of the project are composed of:
(+) Liquidation/Salvage Value$25,000 (-) Book Value of
Equipment0(=) Capital Gains$25,000 (-) Tax Liability
$5,250(+) Recall NWC $32,783(=) Terminal Cash Flows$52,533
Relevant Cash Flow for the Project
Yea
+52,533
Year Project Cash Flow0 (265,000)1 110,382
2 123,493 3 111,397 4 163,016
20
Decision Rules
Net Present Value
Internal Rate of Return (IRR)
MIRR
Profitability Index
Payback Period

Decision Rule #1: Net Present Value 01234 (265,000)
110,382 123,493 111,397 163,016
Decision Rule #1: Net Present Value
be executed.
We can also use =NPV function to calculate the PV of project
cash flows and then subtract the initial outlay from the PV of
cash flows.
Decision Rule #2: IRR01234 (265,000) 110,382
123,493 111,397 163,016
Decision Rule #2: IRR

There is no closed form solution for this equation; we need an
algorithm to solve it. We can use =IRR function in Excel to
solve the equation.
be executed!
Decision Rule #3: Modified IRR
IRR assumes that investment cash flows can be reinvested at the
IRR (similar to YTM of a bond); however this may be an
optimistic assumption; therefore IRR may overstate the project
performance.
A realistic, and relatively conservative approach is to assume
reinvesting the project cash flows at the cost of capital.
This approach is referred to as Modified IRR or MIRR.
Manual MIRR Calculation
Step-1:
Calculate future value of all the cash flows at the end of project
life assuming that they will be reinvested at cost of capital

Step-2:
Aggregate the future value of all cash flows
Step-3:
Calculate CAGR or Geometric Mean Return of the investment
MIRR Calculation
We can also calculate the MIRR in Excel using MIRR function;
it requires
MIRR Calculation in Excel: =MIRR
The function requires a finance rate and reinvestment rate;
finance rate is the cost of capital, reinvestment rate can be set
any rate, but the general assumption is the cost of capital
Profitability Index
Profitability index reflects the benefit cost ratio of a project. It
is the ratio of PV of project cash flows to the project cost.
NEC expansion project, generates $1.50 PV per $1 invested;
this suggests significant benefits for every dollar invested. It

points to execution of the project
28
Profitability Index
NEC expansion project, generates $1.50 PV per $1 invested;
this suggests significant benefits for every dollar invested. It
points to execution of the project

29
Payback Period
Note that the cost for the investment, 265,000 can be recovered
sometime between 2nd and 3rd year. The portion recovered in
the 3 year is (265,000-233,874.50)/111,396.88=0.28. Therefore
the payback period for the investment is 2 years + 0.28 years or
~2.28 years
Year FCFPCumulative FCFP1 110,382.00 110,382.00 2
123,492.50 233,874.50 3 111,396.88 345,271.38 4
163,016.33 508,287.71
The cost for the investment, 265,000 can be recovered sometime
between 2nd and 3rd year. The portion recovered in the 3 year
is (265,000-202,407)/83,694.12=0.75. The discounted payback
period for the investment is 2 years + 0.75 or ~2.75 years.
Year FCFPPV of Cash FlowsCumulative PV1 110,382.00
100,347.27 100,347.27 2 123,492.50 102,059.92
202,407.19 3 111,396.88 83,694.12 286,101.31 4
163,016.33 111,342.35 397,443.66
Conclusion
Given the information, NEC Expansion project is a value
creating project and it should be executed.
It has significantly positive NPV and MIRR well above cost of
capital.
Other decisions rules such as PI also points to a favorable

conclusion. The payback period is relatively short, and the
investment is recovered in early or mid second year.
Note that the project cash flows are expected cash flows; they
are the mean of a distribution and the realized cash flows may
be materially different from these.
It is always prudent to conduct a sensitivity analysis to
understand the project risks and the conditions under which the
project lead to sub optimal results.
Question
Do you prefer a $1 project with 100% IRR or $100 project wi th
10% IRR? Why?
Projects with unequal economic lives
So far we conveniently assumed that mutually exclusive
projects we evaluated had equal economic lives.
What if the economic lives of the projects are not equal? Should
we still go ahead and use NPV of each project and compare
them?
Would this be an apples to apples comparison?
What assumptions are necessary to make sound decisions?
Sorting out Unequal lives
Two approaches:
Annualized NPV or ANPV Approach
Common Economic Life Approach

In both cases we implicitly assume that projects can be
repeated.
Capital Budgeting: Projects with Unequal Lives
Shao Airlines is considering two alternative planes.
Plane A has an expected life of 5 years, will cost $100 million,
and will produce net cash flows of $30 million per year.
Plane B has an expected life of 10 years, will cost $132
million, and will produce net cash flows of $25 million per
year.
Shao plans to serve the route for 10 years. Inflation in operating
costs, airplane costs, and fares is expected to be zero, and the
company’s cost of capital is 12 percent.
By how much would the value of the company increase if it
accepted the better project (plane)?
Approach-1: Annualized NPV (ANPV)
This approach requires calculation of annualized contribution of
the project to NPV, and implicitly assumes that project can be
repeated indefinitely generating the perpetual ANPV.
Three steps:
Step-1: Calculate NPV for each project
Step-2: Calculate annualized contributions to NPV or ANPV
Step-3: Assume that annualized NPV will be created perpetually
and calculate the perpetual value of each project; select the
project with higher value

Annualized NPV (ANPV) Approach
Project-A
Project-B
Hint: You can use PMT function in Excel to calculate ANPV;
NPV is the PV
Common Economic Life Approach
This approach requires finding a common economic life for both
projects.
For instance by assuming that 5 year project can be repeated
once to create a 10 year project , we can calculate NPV of both
project under the assumption that 5 year project repeated once
by investing the original $100m at the end of the year five.
The assumption is that the project will generate same cash flows
as in years 1 through 5 during years 6 through 10.
If one of the projects had a 3 year economic life and the second
one had 5 year economic life, the common economic life would
be 15 years. In this case first project will be assumed to be
repeated 5 times while the second project will be assumed to be
repeated 3 times.

Common Economic Life ApproachCommon Economic Life
ApproachRequired Rate of Return=12%AB0-100,000,000.00 -
132,000,000.00 1 30,000,000.00 25,000,000.00 2 30,000,000.00
25,000,000.00 3 30,000,000.00 25,000,000.00 4 30,000,000.00
25,000,000.00 5-70,000,000.00 25,000,000.00 6 30,000,000.00
25,000,000.00 7 30,000,000.00 25,000,000.00 8 30,000,000.00
25,000,000.00 9 30,000,000.00 25,000,000.00 10 30,000,000.00
25,000,000.00 NPV 12,764,005.28 $9,255,575.71
In this case, project A is expected to be repeated twice; the
investment is made at the end of year 5 and cash flows are
expected to be repeated from years 6 through year 10
How should firms pursue investment opportunities?
When there are no limits to capital budget, and the firm faces
mutually exclusive projects, decision rules like NPV and IRR
should guide the investment decisions. The ultimate criteria is
the value created by the project!
When there are no limits to capital budget, and the firm faces a
number independent projects, firm should pursue all the positive
NPV projects.
When there are limits to capital (capital rationing), firm should
adopt all the positive NPV projects until it consumes its budget.
This may require optimization with capital constraints.
Simple Example-1: Mutually Exclusive Projects

If the company can raise large amounts of money at an annual
cost of 15%, and if the investments are mutually exclusive,
which project should the company undertake?
Answer:
Undertake investment A because it has the highest NPV, and
NPV is a direct measure of the increase in wealth from
undertaking the investmentInvestmentABCInitial Cost $
5,500,000 $ 3,000,000 $ 2,000,000 Expected Life
(yrs.)10 10 10 NPV @15% $ 340,000 $ 300,000 $
200,000 PI @ 15%1.061.101.10IRR20%30%40%
Example-2: Independent Projects with Capital Constraints
Considering only these three independent investments, if the
company has a fixed capital budget of $5.5 million, which
projects should the company undertake?
InvestmentABCInitial Cost $ 5,500,000 $ 3,000,000 $
2,000,000 Expected Life (yrs.)10 10 10 NPV @15% $
340,000 $ 300,000 $ 200,000 PI @
15%1.061.101.10IRR20%30%40%
If the capital budget is fixed at $5.5 million, invest in C and B,
and put the remaining $500,000 in A if possible.
This is the bundle of investments with the highest total NPV.
One can select this bundle by ranking investments by their IRR,
or occasionally more accurately by their PI (or Benefit Cost
Ratio or BCR)

Appendix-I: More on IRR
Important Characteristics of IRR
IRR is highly sensitive to the timing of the cash flows
IRR is blind to the size of the investment;
When cash flows are unconventional (i.e. project cash flows
change sign more than once) IRR produces multiple solutions. It
is difficult to economically interpret multiple IRRs.
Under some circumstances, there is no IRR!
would you rather have a small project with a higher rate of
return or a large project with a lower rate of return? Sometimes,
the larger, low rate of return projects have the higher NPVs.
46
Project Scale and IRR-NPV Conflict
As the NPV profile
Shows, project B has higher NPV for discount rates between 0
and 21.83%
47
Multiple IRR Problem
Unconventional cash flows where the sign of cash flows change
more

than once, produce multiple IRRs. For instance the following
cash flow
pattern leads and IRR of 100% and 200%.
In this case NPV profile of the project intersects the horizontal
line twice:
at discount rate 100% and discount rate 200%.
48
Multiple IRR Problem
200%
100%
49
No IRR Problem
In some cases, NPV profile may never cross the horizontal axis.
50
Appendix-II: Replacement Projects
Replacement Projects
The example we considered is an “Expansion Project”. In this

case the company expanded its existing capacity and we
evaluated if the expansion was economical in the sense that if it
added value for investors.
Our conclusion was affirmative as project had positive NPV and
its IRR exceeded its cost of capital.
Companies also frequently engage in “Replacement” projects.
Replacement analysis is a little more complicated and it
requires us to focus on incremental cash flows.
Now we will frame the investment project as a Replacement and
conduct the analysis.
Lasting Impressions LLC: Replacement Project
Lasting Impressions (LI) Company is a medium- sized
commercial printer of promotional advertising brochures,
booklets, and other direct-mail pieces.
The typical job is characterized by high quality and production
runs of more than 50,000 units.
LI has not been able to compete effectively with larger printers
because of its existing older, inefficient presses.
Lasting Impressions LLC
The firm is currently having problems in meeting demand cost
effectively and quality requirements of the industry.
The general manager has proposed the purchase of one of two
large, six-color presses designed for long, high- quality runs.

The purchase of a new press would enable LI to reduce its cost
of labor and therefore the price to the client, putting the firm in
a more competitive position.
LI Investment Proposals
Keep the Old Equipment
Replace it with highly automated press that can be purchased
for $830,000 and will require $40,000 in installation cost
Replace it with a less sophisticated press that can be purchased
for $640,000 and requires $20,000 in installation costs.
Existing Equipment (Old Equipment)
Old press Originally purchased 3 years ago at an installed cost
of $ 400,000, it is being depreciated under MACRS using a 5-
year recovery period.
The old press has a remaining economic life of 5 years. It can
be sold today to net $ 420,000 before taxes; if it is retained, i t
can be sold to net $ 150,000 before taxes at the end of 5 years.
5 Year MACRS – 20% 32% 19% 12% 12% 5%
56
Alternative-1: Press-A
This highly automated press can be purchased for $ 830,000 and

will require $ 40,000 in installation costs.
It will be depreciated under MACRS using a 5- year recovery
period. At the end of the 5 years, the machine could be sold to
net $ 400,000 before taxes.
If this machine is acquired, it is anticipated that the current
asset changes on the left would result:
Cash $25,400 A/R$120,000 Inventories($20,000)A/P$35,000
57
5 Year Modified Accelerated Cost Recovery System
(MACRS)Depreciation MACR-
5Yr120%232%319%412%512%65%
Alternative-2: Press-B
This press is not as sophisticated as press A. It costs
$640,000 and requires $20,000 in installation costs.
It will also be depreciated under MACRS using a 5- year
recovery period.
At the end of 5 years, it can be sold to net $ 330,000 before
taxes.
Acquisition of this press will have no effect on the firm’s net
working capital investment.
59

Earning Projections Before Depreciation Interest and
TaxesEBITDAYearOld PressPress APress
B1$120,000$250,000$210,0002$120,000$270,000$210,0003$12
0,000$300,000$210,0004$120,000$330,000$210,0005$120,000$
370,000$210,000
The firm is subject to a 40% tax rate. The firm’s cost of capital,
r, applicable to the proposed replacement is 14%.
60
Tasks
A. For each of the two proposed replacement presses,
determine:
Initial investment.
Operating cash inflows
Terminal cash flow
B. Using the data developed at the stage A, apply decision
rules to make a recommendation to the management team.
61
Initial Investment OutlayItem Press A Press BCost of Old
Machine$400,000$400,000Cost of New
Machine$870,000$660,000Proceeds from Old
Machine$420,000$420,000Book Value of Old
Machine$116,000$116,000Gains from
Sale$304,000$304,000Tax Liability $121,600$121,600NWC

Investment$90,400$0Net Initial Outlay$662,000$361,600
Book value of the old machine: 400,000-
(80,000+128,000+76,000)=116,000
400,000x0.2=80,000
400,000 x0.32=128,000
400,000x0.19=76,000
Cumulative Depreciation=284,000
62
Depreciation of The New and Old EquipmentDepreciation
MACR-5YrPress APress BExisting
120%$174,000$132,000$48,000232%$278,400$211,200$48,000
319%$165,300$125,400$20,000412%$104,400$79,200$0512%$
104,400$79,200$065%$43,500$33,000$0
63
Net Operating Cash Flows: Old MachineExisting
Machine12345(+)
EBITDA120000120000120000120000120000(-) Depreciation
$48,000$48,000$20,000$0$0(=)
EBIT$72,000$72,000$100,000$120,000$120,000(-)
Taxes$28,800$28,800$40,000$48,000$48,000(=)
NOPAT$43,200$43,200$60,000$72,000$72,000(+) Depreciation
$48,000$48,000$20,000$0$0(=)
NOCF$91,200$91,200$80,000$72,000$72,000

64
Net Operating Cash Flows: Press-APRESS-
A:12345EBITDA$250,000$270,000$300,000$330,000$370,000
Depreciation 174000278400165300104400104400EBIT$76,000-
$8,400$134,700$225,600$265,600Taxes30400-
33605388090240106240NOPAT$45,600-
$5,040$80,820$135,360$159,360Depreciation
174000278400165300104400104400NOCF$219,600$273,360$2
46,120$239,760$263,760
65
Net Operating Cash Flows: Press-BPRESS-
B:12345EBITDA$210,000$210,000$210,000$210,000$210,000
Depreciation 1320002112001254007920079200EBIT$78,000-
$1,200$84,600$130,800$130,800Taxes31200-
480338405232052320NOPAT$46,800-
$720$50,760$78,480$78,480Depreciation
1320002112001254007920079200NOCF$178,800$210,480$176,
160$157,680$157,680
66
Incremental Operating Cash Flows for Press A &
BColumn112345Existing
Machine$91,200$91,200$80,000$72,000$72,000Press-A
$219,600$273,360$246,120$239,760$263,760Press-
B$178,800$210,480$176,160$157,680$157,680Press A
IOCF$128,400$182,160$166,120$167,760$191,760Press B

IOCF$87,600$119,280$96,160$85,680$85,680
IOCF=Incremental Operating Cash Flows
67
Terminal Cash FlowsTerminal Cash FlowsPress APress BOld
Mach.Proceeds from Liquidation
$400,000$330,000$150,000BV at Liquidation
$43,500$33,000$0Profit from
Sale$356,500$297,000$150,000Tax
Liability$142,600$118,800$60,000Net Proceeds from
Sale$257,400$211,200$90,000Recall NWC
Investment$90,400$0$0Net Terminal Cash
Flows$347,800$211,200$90,000Net Incremental
TCF$257,800$121,200
347,800-90,000=257,800
211,200-90,000=121,200
68
Relevant Cash Flow for the ProjectsYearPress APress B0-
$662,000-
$361,6001$128,400$87,6002$182,160$119,2803$166,120$96,16
04$167,760$85,6805$449,560$206,880
Year 5 cash flows include terminal cash flows
69

Cash Flows on a Time Line
70
Pay Back Period AnalysisPayback Period Press APress
B1$128,400$87,6002$310,560$206,8803$476,680$303,0404$64
4,440$388,7205$1,094,000$595,600
Cumulative Cash Flows
Note that the cost for Press A (662,000) can be recovered only
sometime
between 4th and 5th year. The portion recovered in the 5th year
is
(662,000-644,440)/449,560=0.0391. Therefore payback period
for the
Press A is 4 years + 0.039 years or ~4.04 years. The recovery
for press B is faster as initial investment of 361,600 can be
recovered in 3.68 years.
In calculation of the payback period, we consider only the
operating cash flows for a given year. For instance, in this
particular case we did not include terminal cash flows of the
project in year 5 cash flows.
71
Discounted Payback PeriodYearPress APress BCumulative Cash
Flows ACumulative
Cash Flows B0 (662,000) (361,600) (662,000)
(361,600)1 112,632 76,842 112,632
76,842 2 140,166 91,782 252,798 168,624 3
112,126 64,905 364,924 233,529 4 99,327

50,729 464,251 284,259 5 233,487 107,447
697,739 391,706 Discounted Payback Period 4.85
4.72
Discounted Payback period requires discounted value of each
cash flow. Each cash flow is discounted to time 0 at the cost of
capital, and payback period is calculated by using these
discounted cash flows. In this particular case, method favors
project “B” as in the standard Payback Period method.
72
NPV Rule
Investment outlay may take place at time 0, or it may spread
over time. If that is the case then IO can be expressed as:
NPV AnalysisYearPress APress B0-$662,000-
$361,6001$128,400$87,6002$182,160$119,2803$166,120$96,16
04$167,760$85,6805$449,560$206,880
NPVPress-A=35,738.82>NPVPress-B=30,105.88
Since both projects have 5 year life spans there is no need to
consider
Annualized NPV, but have we had done it, ANPV-A would have
been higher than ANPV-B.

74
IRR and MIRR
IRR is the rate of return that equates the present value of the
project cash inflows to initial outlay; alternatively it can be
described as the rate of return that satisfies NPV=0
IRR implicitly assumes that project cash flows are reinvested at
the IRR
If we revise that assumption and assume that cash flows are
reinvested at cost of capital we get MIRR
IRR
Project A’s IRR is 15.8,
Project B’s IRR is 17.06.
Both projects have IRR above cost of Capital. If we used IRR to
choose the projects, Press B would be favored by the IRR
method. Note that IRR assumes that cash flows can be
reinvested at the IRR.
A consideration of reinvestment at cost of capital (MIRR)

suggest that ranking does not change. MIRR-A=15% MIRR-
B=16%
76
Profitability Index
LI’s two projects have PIA=1.05 and PIB=1.08 . While
profitability index suggests that project B generates more value
per dollar invested, the total value created by project A is
higher.
77
SummaryProject AProject B0-$662,000-

$361,6001$128,400$87,6002$182,160$119,2803$166,120$96,16
04$167,760$85,6805$449,560$206,880NPV$35,738.82$30,105.
88IRR15.85%17.06%MIRR15.21%15.84%PI1.051.08Payback4.
043.68
Conflict between NPV and IRR
Two questions arise:
Why do these two methods disagree?
What do we do?
The “Why?” question
NPV and IRR decision rules usually agree; but under some
circumstances conflicts may emerge simply because of:
Size of projects;
Differing cash flow patterns
When the cost of capital of the project is below the point where
NPV curves of the mutually exclusive projects cross-over, the
NPV and IRR contradict each other.
Cost of Capital (14%)<Cross-over Point (14.59%)
14%< Cross-over point=14.59%
Project A
Project B
81
NPV_A Cost of Capital 0.05 0.06 0.07 0.08 0.09 0.1 0.11
0.12 0.13 0. 14 0.15 0.16 0.17 0.18 0.19 0.2 0.21
0.22 0.23 0.24 0.25 0.26 0.27 0.28 0.29 0.3
259269.49651832771 229550.3994204925

201222.3696731271 174204.73043695919
148422.27985137681 123804.8692650153
100287.01764169781 77807.558734363061
56309.31796841661 35738.816286218971
16045.9984808144 -2816.0162066004768 -
20891.16323104826 -38220.643439061212 -
54843.116948258212 -70794.881687242771 -
86110.037930901162 -100820.6400397197 -
114956.8364982255 -128546.9992456288 -141617.8432 -
154194.53679468151 -166300.80427122701 -
177959.02040600771 -189190.29828704981 -
200014.57070292209 NPV_B Cost of Capital 0.05 0.06
0.07 0.08 0.09 0.1 0.11 0.12 0.13 0.14 0.15 0.16 0.17
0.18 0.19 0.2 0.21 0.22 0.23 0.24 0.25 0.26 0.27 0.28
0.29 0.3 145670.71245299769 130397.4309240104
11581 5.5768085709 101885.8034831503
88571.402798039198 75838.103457910765
63653.886595667602 51988.816927099098
40814.888038390061 30105.88050491759
19837.23167022027 9985.9160303501831
530.33527269388935 -8549.7828888313707 -
17273.47785724566 -25658.64197530851 -
33722.099661655462 -41479.68043445173 -
48946.286343020161 -56135.954279608341 -63061.9136
-69736.639442548505 -76171.902099925908 -
82378.812766075134 -88367.865952089429 -
94148.978838814641
Cost of Capital and NPVCost of Capital NPV Press A NPV
Press
B0.11$100,287$63,653.890.12$77,808$51,988.820.13$56,309$4
0,814.890.14$35,739$30,105.880.15$16,046$19,837.230.16-
$2,816$9,985.920.17-$20,891$530.340.18-$38,221-
$8,549.780.19-$54,843-$17,273.48
As the above table shows, when cost of capital is

approximately
Below 15%, press A has higher NPV than Press B.
But this changes when the cost of capital Increases to 15% and
Beyond. This suggest a cross-over point between 14 and 15%
(14.59)
cost of capital.
82
The “What to do?” question
The answer is straightforward: when there is a conflict choose
NPV
Caveat: When the conflict arise because of size and if the small
project has high IRR, we need to ask the following question:
Can we mobilize the excess capital to generate a net present
value in access of the differential NPV between the small and
the large project?
If the answer is yes, small project can be given priority. In
practice this is a difficult question to answer.
Example
In our illustrative case LI, project A has roughly 5K higher
NPV than project B:
- $30,105.88=$5,633
If Excess Capital =662,000-361,600=$300,400 can be
mobilized to a new project with NPV in excess of 5,633,
project B may be preferable.
Otherwise, project A should be selected!

Incremental Cash Flows Approach Project AProject
BIncremental Cash Flows
0($662,000)($361,600)($300,400)1$128,400 $87,600 $40,800
2$182,160 $119,280 $62,880 3$166,120 $96,160 $69,960
4$167,760 $85,680 $82,080 5$449,560 $206,880 $242,680
NPV$35,738.82 $30,105.88 IRR15.85%17.06%15%
Another way to rest the conflict is to measure the IRR of the
incremental cash flows. If the IRR of the incremental cash flows
of the larger project exceed the required return, the larger
project should be chosen. In our example IRR of the
incremental cash flows exceed cost of capital of 14%; we can
conclude that project A should be chosen.
>14%
Note that when we use the IRR method:
We choose project B because it has higher IRR
We also choose the hypothetical incremental project (A-B) as it
has IRR> Cost of Capital
This amounts to selecting: B +(A-B)=A
An important point to emphasize is the IRR’s blindness to
optimal scale of investment; NPV, therefore is a superior
decision rule as compared to IRR.
NPV can be construed as an absolute dollar return measure
whereas IRR is a percentage return method.
Example: Project Size, IRR & NPV Conflict
Consider the two projects above with different initial outlays
and cash flow structures. The company in question should
choose one of these two service station projects. Which one
should company adopt? Since these are mutually exclusive

projects, it does not make sense to adopt both.
NPV at 10%PI at 10%IRRInexpensive
Project92,5001.1814%Expensive Project98,2001.0912%
Mutually Exclusive Projects and NPVNPV at 10%PI at
10%IRRInexpensive Project92,5001.1814%Expensive
Project98,2001.0912%
While the expensive project’s direct contribution to shareholder
wealth is larger, inexpensive project earns higher return on
each dollar invested, and has a higher return.
The impressive performance of inexpensive project documented
in PI and IRR obviously in conflict with the value
maximization objective.
What should company do? If company invests $1.1m it creates
$7,700 more value! However, investing $522,000 makes
$578,000 available.
If the company had an opportunity to deploy this amount to
create NPV in excess of $7,700 by taking same level of risk,
inexpensive project would be viable.
Otherwise, the firm should go for the expensive project. Scale
insensitivity of PI and IRR confirms the use of NPV as an
appropriate figure of merit.
234
110,382123,493111,397163,016
265,000
(10.1)(10.1)(10.1)(10.1)
397,443.66265,000132,443.66
NPV

NPV
=+++-
++++
=-=
NPV =
FCFPt
(1+ k )t
−
t=1
N
∑ IO > 0
NPV=
FCFP
t
(1+k)
t
-
t=1
N
å
IO>0
12
12
.........
(1)(1)(1)
N
N

AAA
FCFP
FCFPFCFP
IO
IRRIRRIRR
=+++
+++
234
110,382123,493111,397163,016
265,000
(1)(1)(1)(1)
IRRIRRIRRIRR
=+++
++++
MIRR =N
FCFt × (1+ k )
N −t
t=1
N
∑
IO
−1
MIRR=
N
FCF
t

´(1+k)
N-t
t=1
N
å
IO
-1
1/4
1
(1)
581,897
1121.73%
265,000
N
Nt
t
N
t
FCFk
MIRR
IO
-
=
´+
æö
=-=-=
ç÷
èø
å
1
397,443.66
(1)
1.50
265,000
N
t

t
t
FCFP
k
PI
IO
=
+
===
å
(
)
(
)
(
)
(
)
+-
=´®=
+´+-
+´
11
111
1
N
NN
N
i
NPV
NPVANPVANPV
iii
ii
=
ANPV
PerpValue

k
Perpetual
Value =
1,638,090
0.12
=13,650,733
Perpetual Value=
1,638,090
0.12
=13,650,733
unequal economic lives EXAMPLE: PROJECTS WITH
UNEQUAL ECONOMIC LIVESAnnualized NPV
ApproachCommon Economic Life ApproachRequired Rate of
Return12%Required Rate of Return12%ABAB- 0-
100,000,000.00- 132,000,0000- 100,000,000.00-
132,000,000.00130,000,000.0025,000,000130,000,000.0025,000
,000.00230,000,000.0025,000,000230,000,000.0025,000,000.00
330,000,000.0025,000,000330,000,000.0025,000,000.00430,000
,000.0025,000,000430,000,000.0025,000,000.00530,000,000.00
25,000,0005-
70,000,000.0025,000,000.00625,000,000630,000,000.0025,000,
000.00725,000,000730,000,000.0025,000,000.00825,000,00083
0,000,000.0025,000,000.00925,000,000930,000,000.0025,000,0
00.001025,000,0001030,000,000.0025,000,000.00NPV$8,143,28
6.07$9,255,575.71NPV12,764,005.28$9,255,575.71ANPV$2,25
9,026.81$1,638,090.33Perpetual
Value18,825,223.3813,650,752.76- 0- 0

Shao Airlines is considering two alternative planes. Plane A has
an expected life of 5 years, will cost $100 million, and will
produce net cash flows of $30 million per year. Plane B has a
life of 10 years, will cost $132 million, and will produce net
cash flows of $25 million per year. Shao plans to serve the route
for 10 years. Inflation in operating costs, airplane costs, and
fares is expected to be zero, and the company’s cost of capital is
12 percent. By how much would the value of the company
increase if it accepted the better project (plane)?
This approach requires annualized contribution of the project to
NPV, and implicitly assumes that project can be repeated
indefinetly generating the perpetual ANPV.
Perpetual Value is calculated with this assumption where
Perpetual Value=ANPV/k
This approach requires finding a common economic life for both
projects. For instance by assuming that 5 year project can be
repeated once to create a 10 year project , we can calculate NPV
of both project under the assumption that 5 year project
repeated once by investing the original 100 m at the end of year
five. The assumption is that the project will generate same cash
flows as in years 1 throgh 5 during years 6 through 10.
If one of the projects had a 3 year economic life and the second
one had 5 year economic life, the common economic life would
be 15 years. In this case first project will be assumed to be
repeated 5 times while the second project will be assumed to be
repeated 3 times.
Sheet53,900,000.000.080048,750,000.0042,750,000.000.145200
6986.2226666EBIT6,000,000.00Tax Rate35%8.75EBIT x (1-
T)3,900,000Unlevered Beta1.1Risk Free
Rate2.50%EMRP5.00%Unlevered CoE8.00%Unlevered Firm
Value48,750,000.00Outsanding Shares400,000Pre Recap Share
Price121.88Cost of Debt2.75%Levered Beta1.2676675Cost of
Levered
Equity8.84%E/V0.8100445525D/V0.1899554475D/E0.2345WA

CC7.50%Value52,006,986.22Theoretical
ITS3,500,000.00Actual
ITS3,256,986.22Debt10,000,000.00Equity42,006,986.22D/E0.2
381Post Reap Share Price130.02Post Recap Outsanding
Shares323,087
Phoenix Inc. is an all-equity firm with 400,000 shares
outstanding. It has $6,000,000 of EBIT, which is expected to
remain constant in the future. The company pays out all of its
earnings, so earnings per share (EPS) equal dividends per share
(DPS). Company's CapEx is equal to its annual depreciation
allocation and change in WCR is expected to be zero in the
foreseeble future. Company's tax rate is 35%.
Phoenix is considering issuing $10,000,000 of 2.75 % bonds at
par value and using the proceeds to repurchase stock. The risk-
free rate is 2.5%, the market risk premium is 5.0%, and firm's
asset beta is 1.10. The CFO estimates that recapitalization
initially will increase firms's D/V ratio to about 19%. Based
on the information provided what is the best estimate of post
recapitalization WACC of Zelnick Inc.?
ANPV =
NPV
(1+i)N −1
(1+i)N ×i
=
8,143,286
(1+0.12)5 −1
(1+0.12)5 ×0.12
⎛
⎝⎜

⎞
⎠⎟
=2,259,027
ANPV=
NPV
(1+i)
N
-1
(1+i)
N
´i
=
8,143,286
(1+0.12)
5
-1
(1+0.12)
5
´0.12
æ
è
ç
ö
ø
÷
=2,259,027
Perpetual

Value =
2,259,027
0.12
=18,825,223
Perpetual Value=
2,259,027
0.12
=18,825,223
ANPV =
NPV
(1+i)N −1
(1+i)N ×i
=
9,255,575
(1+0.12)10 −1
(1+0.12)10 ×0.12
⎛
⎝⎜
⎞
⎠⎟
=1,638,090

ANPV=
NPV
(1+i)
N
-1
(1+i)
N
´i
=
9,255,575
(1+0.12)
10
-1
(1+0.12)
10
´0.12
æ
è
ç
ö
ø
÷
=1,638,090
IO =
IOt
(1+ k )tt=1
N
∑

IO=
IO
t
(1+k)
t
t=1
N
å
NPVA =
128, 400
(1+ 0.14)1
+
182,160
(1+ 0.14)2
+
166,120
(1+ 0.14)3
+
167,760
(1+ 0.14)4
+
449,560
(1+ 0.14)5
− 662,000 = 35,738.82

NPV
A
=
128,400
(1+0.14)
1
+
182,160
(1+0.14)
2
+
166,120
(1+0.14)
3
+
167,760
(1+0.14)
4
+
449,560
(1+0.14)
5
-662,000=35,738.82
123
45
87,600119,28096,160
(10.14)(10.14)(10.14)
85,860206,880
361,60030,105.88
(10.14)(10.14)
B
NPV
=+++
+++
+-=
++

IO =
FCF1
(1+ IRRA )
1 +
FCF2
(1+ IRRA )
2 + .........+
FCFN
(1+ IRRA )
N
IO=
FCF
1
(1+IRR
A
)
1
+
FCF
2
(1+IRR
A
)
2
+.........+
FCF

N
(1+IRR
A
)
N
IO =
FCFt × (1+ k )
N −t
t=1
N
∑
(1+ MIRR) N
IO=
FCF
t
´(1+k)
N-t
t=1
N
å
(1+MIRR)
N
12345
128,400182,160166,120167,760449,560
662,000
(1)(1)(1)(1)(1)
AAAAA

IRRIRRIRRIRRIRR
=++++
+++++
12345
87,600119,28096,16085,860206,880
361,600
(1)(1)(1)(1)(1)
BBBBB
IRRIRRIRRIRRIRR
=++++
+++++
1
(1)
N
t
t
t
FCFP
k
PI
IO
=
+
=
å
697,739
1.05
662,000
A
PI
==
391,705
1.08
361,600
B
PI

DB#3 Sneaker 2013The objective of the Case Debriefings is

Recommended

Recommended

More Related Content

More from LinaCovington707

More from LinaCovington707 (20)

DB#3 Sneaker 2013The objective of the Case Debriefings is