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
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?
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!