Capital Budgeting Problem: Fairways Driving Range Two Friends Are Considering Opening A Driving Range For Golfers. Because Of The Popularity Of Golf In Pittsburgh, They Estimate That They Could Rent 20,000 Buckets At $3 A Bucket In The First Year, And That Rentals Will Grow By 750 Buckets A Year Thereafter. The Price Will Remain At $3 Per Bucket. Equipment
Capital Budgeting Problem: Fairways Driving Range Two friends are considering opening a driving range for golfers. Because of the popularity of golf in Pittsburgh, they estimate that they could rent 20,000 buckets at $3 a bucket in the first year, and that rentals will grow by 750 buckets a year thereafter. The price will remain at $3 per bucket. Equipment (Ball Dispensing Machine = $2,000, Tractor and Accessories = $8,000, Ball Pickup Machine = $8,000) is 5-year ACRS and is expected to have a salvage value of 10% of cost after 6 years. Expenditures for balls and buckets are $3,000 initially. The cost of replacing balls and buckets will grow at 5% per year. Net working capital needs are $3,000 to start. Thereafter, NWC grows at 5% per year. The relevant tax rate is 15 percent. The required rate of return is 12 percent. Evaluate the project for 6 years. Should your friends proceed with the project? Fairways Driving Range: Operating Costs per Year Step 1: Revenue Forecast Step 2: Forecasting the cost of balls and buckets Step 3: Depreciation Step 4: Pro-forma Income Statement Step 5: Forecasting Operating Cash Flows Project Capital Spending During the project’s life, additional assets sometimes need to be bought, and/or some assets need to be replaced. This cash cannot be consumed by investors – we need to deduct capital spending from Free Cash Flows! In every year of project’s expected life, we will compute capital spending as: + purchase price of the new asset bought - selling price of the asset sold +/- increase (decrease) in tax liability due to sale of old asset at other than book value When the finite-life project ends, we will liquidate all assets used. How? We will sell them if they still have some salvage value (= the market value of an asset at the project’s end) Project Capital Spending – Tax Adjustment We will compare the selling price of the asset (S) and the book value of the asset at the time of the sale (B). Our adjustment to the capital spending will be: 1) If S>B, then we add T*(S-B) to capital spending (i.e. deduct from FCF) 2) If B>S then we deduct T*(B-S) from capital spending (i.e. add to FCF) Why? Step 6: Project Capital Spending Addition to Net Working Capital (NWC) Additions to Net working capital (NWC) = = (ending NWC – beginning NWC)
Q: What is ‘Net Working Capital’?