Hi PrepLounge community,
I stumbled upon a difficult question in a recent case - looking forward to hearing your inputs on this!
Scenario (numbers are simplified)
- A tourism investment yields a positive cash flow of 15M every year, with no growth (perpetuity rent)
- We have an up-front investment of 100M
- Cost of capital = 10%
- NPV = -100 + 15/0.1 = 50M
Question and answer
Question
Your client is not satisfied by the NPV: 50M is too low. From a financial perspective, what could she do to improve the NPV to 100M?
And are these options difficult, medium or easy to implement?
Answer
We could:
i) Try to lower the cost of capital to 7.5% from 10%
--> By finding cheaper ways of financing such as public funding.
Level: medium, possible only if public funding is available or if we have debt in our financing mix.
ii) Try to have a constant growth rate of Cash Flow of ~2.5%
--> By increasing each year Q (thru occupancy) or P (thru added services)
Level: easy, it's doable to have a +2.5% in the first years of a new business
iii) Try to increase Cash Flow to +20M a year from +15M
--> By finding extra sources of revenues, even if gross margin is relatively reduced
Level: difficult, +33% a year is a huge increase if we keep the same biz model
iv) Try to reduce Capex to -50M from -100M
--> By drastically reducing infrastructure costs
Level: difficult, we can't expect the same level of revenues if we slash the quality/quantity of our infrastructure
v) A mix of these approaches
I feel like this is a very standard approach, I have no experience in finance. What would you add/comment to this answer?
Thank you in advance for your support!
Dee
