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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%.
Problem 1: What would the investment need to be for this project to be breakeven (ignoring depreciation effects of the investment)?
Assume that
1) Everything grows at 3% per year from year 2 onwards to infinity; and
2) The cash flow stream that goes from time 0 on indefinitely is similar in nature to a long term treasury bond.
Compute for the projects NPV and decide whether you should take the project or not.
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