# Capital Budgeting techniques such as NPV and APV

Vulture Partners, a private equity organization specializing in distressed company investing, was interested in purchasing a company called Turnaround. Mr. Fang, a general partner at Vulture, made the following projections to value Turnaround ($mm):

Year 1 Year 2 Year 3 Year 4 Year 5

Revenue

200 210 220 230 240

Costs

(100) (105) (110) (115) (120)

EBIT

100 105 110 115 120

D NWC

+3 +3 +4 +4 +5

Turnaround had $220 million of net operating losses (NOLs) that were available to offset future income. At the beginning of year 1, the company had $75 million of 8% debt (coupon & yield) which was expected to be repaid in three $25 million installments beginning at the end of year 1. The relevant tax rate is 40%. Mr. Fang believed that an appropriate unlevered beta for Turnaround was 0.8. The long-term treasury yield was 6.5 percent and the market risk premium 7.0%. Net cash flows were forecast to grow at 3 percent per year in perpetuity after year 5. Calculate the APV of Turnaround and do a sensitivity analysis on the perpetuity growth rate at 2 and 4 percent.

Also, will you use excel formulas in your solutions/answers or will provide everything calculated using non-excel formulas?

See attached file for full problem description.

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#### Solution Preview

ASSUMPTIONS

1 Present value of tax shield is calculated @8% borrowing rate. It is assumed that

tax shields are just as risky as the interest payments generating them.

2. For first two years there will be no taxes and third year 15mn$ will have no taxes

as it will be set off against losses

3. Interest tax shield is calculated Interest* tax rate

CALCULATION OF COST OF CAPITAL

Ke = Rf+b(Km-Rf)

Ke= Cost of Equity capital

Rf= Risk free Rate 0.065

Km= Expected market return 0.135

b=beta coefficient 0.8

Ke 12.10%

APV= BASE CASE ...

#### Solution Summary

This explains the concept of long term investment decision making and also contains step by step demonstration of calculating NPV and APV of the project.