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2023/9/4 18:12 Corporate Finance 6E, Fall 1 2023-Yueheng Wang Student: Yueheng Wang Course: Corporate Finance 6E, Fall 1 2023 Instructor: Ko Wang Book: Berk/DeMarzo: Corporate Finance, 6e Date: 9/4/23 Time: 6:12 PM Facebook is considering two proposals to overhaul its network infrastructure. They have received two bids. The first bid from Huawei will require a $26 million upfront investment and will generate $20 million in savings for Facebook each year for the next 3 years. The second bid from Cisco requires a $105 million upfront investment and will generate $60 million in savings each year for the next 3 years. a. What is the IRR for Facebook associated with each bid? b. If the cost of capital for each investment is 15%, what is the net present value (NPV) for Facebook of each bid? Suppose Cisco modifies its bid by offering a lease contract instead. Under the terms of the lease, Facebook will pay $32 million upfront, and $35 million per year for the next 3 years. Facebook's savings will be the same as with Cisco's original bid. ¢. Including its savings, what are Facebook's net cash flow under the lease contract? What is the IRR of the Cisco bid now? d. Is this new bid a better deal for Facebook than Cisco's original bid? Explain. a. What is the IRR for Facebook associated with each bid? Here is the cash flow timeline for Huawei: Time 0 1 2 3 1 ] ] 1 I I | I CF Huawei = $26 million $20 million $20 million $20 million And for Cisco, here is the cash flow timeline: Time 0 1 2 3 CF Cisco - %105 million $60 million $60 million $60 million The net present value (NPV) is the sum of the discounted cash flows at time 0. To find the internal rate of return (IRR), set the NPV equal to 0 and solve for r: n Ct NPV=0= 7 t=0 (1 +r) where Cy is the cash flow at time &. For Huawei, we have the following summation: =$26 million $20 million $20 million $20 million = + + + (1+n° (1+n° (1+n? (1+n° We can solve for r (the IRR) using an iterative technique, or a financial calculator, where our Cy = — $26 million and subsequent cash flows are $20 million each. Calculating the IRR, we arrive at a value of 57.07% for the IRR associated with the Huawei opportunity. Similarly for Cisco, we have: - $105 million $60 million $60 million $60 million 0= + + + (1+n)° (1+n] (1+n)? (1+n° Solving again for the IRR, we have a value of 32.68% for the IRR associated with the Cisco opportunity. We can compute the IRR using a spreadsheet. For Huawei, we have: A B C D E F 1 |Period 0 1 2 3 2 |C(t) -26 20 20 20 3 |IRR 57.07% |FIRR(B2:E2,0.1) 4 I Calculating the IRR, we arrive at a value of 57.07% for the IRR associated with the Huawei opportunity. Similarly for Cisco, we have: A B C D E F 1 |Period 0 1 2 3 2 |C(t) -105 60 60 60 3 |IRR 32.68% |-IRR(B2:E2,0.1) 4 I Solving again for the IRR, we have a value of 32.68% for the IRR associated with the Cisco opportunity. https://xlitemprod.pearsoncmg.com/apifv1/print/en-us/highered 1/2

2023/9/4 18:12 Corporate Finance 6E, Fall 1 2023-Yueheng Wang b. If the cost of capital for each investment is 15%, what is the net present value (NPV) for Facebook of each bid? The NPV of each opportunity is the present value (PV) of each set of cash flows at the given cost of capital minus the cost of the each investment. n Ct NPV= ). t t=g (111) For Huawei, here is the cash flow timeline: $20 million $20 million $20 million PV = ] + > + 3 $26 million = $19.66 million (1.15) (1.15) (1.15) Similarly for Cisco, here is the cash flow timeline: $60 million $60 million $60 million PV = + + (1+1.15)' (1+1.152 (1+1.15)3 - $105 million = $31.99 million Therefore, the net present value of the opportunity with Huawei at the given cost of capital is $19.66 million. For the opportunity with Cisco, the NPV is $31.99 million. We can compute the NPV using a spreadsheet. For Huawei, we have: NPER RATE PV PMT FV Excel Formula Given 3 15% -20 0 Solve for PV 19.66 =PV(0.15,3, - 20,0) - 26 Similarly for Cisco, we have: NPER RATE PV PMT FV Excel Formula Given 3 15% -60 0 Solve for PV 31.99 =PV(0.15,3,-60,0)- 105 Therefore, the net present value of the opportunity with Huawei at the given cost of capital is $19.66 million. For the opportunity with Cisco, the NPV is $31.99 million. Suppose Cisco modifies its bid by offering a lease contract instead. Under the terms of the lease, Facebook will pay $32 million upfront, and $35 million per year for the next 3 years. Facebook's savings will be the same as with Cisco's original bid. ¢. Including its savings, what are Facebook's net cash flow under the lease contract? What is the IRR of the Cisco bid now? Here is the cash flow timeline for Cisco: Time 0 1 2 3 CF Cisco —$32 million $25 million $25 million $25 million For Cisco's new bid with the lease, we have the following summation: 0= - $32 million .\ $25 million . $25 million .\ $25 million (1+n° (1+n)] (1+n? 1+n° We can solve for r (the IRR) using an iterative technique, or a financial calculator, where our Cy = — $32 million and subsequent cash flows are $25 million ($60 million — $35 million) each. Calculating the IRR, we arrive at a value of 58.51% for the cash flows associated with the new Cisco bid with the lease. For Cisco's new bid with the lease, we compute the IRR as follows: A B C D E F 1 |Period 0 1 2 3 2 [c() - 32 25 25 25 3 [IRR 58.51% |=IRR(B2:E2,0.1) 4 I Calculating the IRR, we arrive at a value of 58.51% for the cash flows associated with the new Cisco bid with the lease. d. Is this new bid a better deal for Facebook than Cisco's original bid? Explain. No. Despite a higher IRR, it actually involves borrowing $73 million upfront and paying $35 million per year, which is a borrowing cost of 20.63%, which is higher than Facebook's borrowing cost. https://xlitemprod.pearsoncmg.com/apifv1/print/en-us/highered 2/2

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