Taurus Inc. hires you to evaluate the acquisition of a wind power plant. The plant’s basic price is $100 million, and would cost another $20 million to modify it for special use by the firm. The plant falls into the MACRS 5-year class, and would be sold after 5 years for an estimated $40 million at market value.
The wind power plant is expected to increase Taurus’s sales revenue by $45 million at Year 1, thereafter growing by 4% per year till the end of project life. The plant will also increase Taurus’ operating costs (i.e., COGS + SGA expenses) by $10 million at Year 1, thereafter growing by 5% per year till the end of project life. Net operating working capital equals 15% of sales revenue projected for the subsequent year.
Taurus’s existing WACC is estimated to be 8.25%. Taurus also has a time constraint policy that requires the full initial investment to be paid back within 5 years.
1) What is the net free cash flow amount of this project for Years 0, 1, 2, 3, 4 and 5, respectively?
2) Should Taurus purchase the wind power plant or not, provided such a development will not considerably alter Taurus’s existing business risk level? (Apply all appropriate major decision rules that you have learned in this course.)
3) Assume Taurus has another investment alternative: to upgrade the existing “fuel-fired power plant”, costing $50 million at Year 0 and generating a net free cash flow of $25 million at Year 1, $20 million at Year 2, $15 million at Year 3, $10 million at Year 4, $5 million at Year 5, $1 million at Year 6, and negative $5 million at Year 7. Also assume (a)the wind and fuel plant projects are both repeatable instead of “one-time deal”, and (b) these two power plant projects are mutually exclusive. Which power plant(s) shall be built? (Apply all appropriate major decision rules that you have learned in this course.)
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