11/26/18
Chapter:	11	Cash Flow Estimation and Risk Analysis
Problem:	18
Webmasters.com has developed a powerful new server that would be used for corporations' Internet activities.It would cost $10 million at Year 0 to buy the equipment necessary to manufacture the server.The project would require net working capital at the beginning of each year in an amount equal to 10% of the year's projected sales; for example, NWC0= 10%(Sales1).
The firm believes it could sell 1,000 units per year. The servers would sell for $24,000 per unit, and Webmasters believes that variable costs would amount to $18,000 per unit.After Year 1, the sales price and variable costs will increase at the inflation rate of 3%.The company's nonvariable costs would be $1 million at Year 1 and also would increase at the 3% inflation rate.
The server project would have a life of 4 years.If the project is undertaken, it must be continued for the entire 4 years. The equipment would be depreciated over a 5-year period, using MACRS rates.The estimated market value of the equipment at the end of the project's 4-year life is $500,000.
Webmasters' federal-plus-state tax rate is 25%.Its cost of capital is 10% for average-risk projects, defined as projects with a coefficient of variation of NPV between 0.8 and 1.2.Low-risk projects are evaluated with a WACC of 8%, and high-risk projects at 13%. Also, the project's returns are expected to be highly correlated with returns on the firm's other assets.
a.Develop a spreadsheet model, and use it to find the project's NPV, IRR, and payback.
Input Data (in thousands of dollars)
Scenario name		Base Case	Note: the items in red will be used in a scenario analysis.
Probability of scenario		50%
Equipmentcost		$10,000
Net operating working capital/Sales	10%		Key Results:
First year sales (in units)		1,000		NPV=	$0
Sales price per unit		$24.00		IRR =	0.0%
Variable cost per unit (excl. depr.)	$18.00		Payback =	0.00
Nonvariable costs (excl. depr.)	$1,000
Inflation in prices and costs	3.0%
Estimated salvage value at year 4	$500
Depreciation years		Year 1	Year 2	Year 3	Year 4
Depreciation rates		20.00%	32.00%	19.20%	11.52%
Tax rate			25%
WACC for average-risk projects	10%
Intermediate Calculations			0	1	2	3	4
Units sold
Sales price per unit (excl. depr.)
Variable costs per unit (excl. depr.)
Nonvariable costs (excl. depr.)
Sales revenue
Required level of net operating working capital
Basis for depreciation
Annual equipment depr. rate					20.00%	32.00%	19.20%	11.52%
Annual depreciation expense
Ending Bk Val: Cost - Accum Dep'rn
Salvage value
Profit (or loss) on salvage
Tax on profit (or loss)
Net cash flow due to salvage
				Years
Cash Flow Forecast			0	1	2	3	4
Sales revenue
Variable costs
Nonvariable operating costs
Depreciation (equipment)
Oper. income before taxes (EBIT)
Taxes on operating income (40%)
Net operating profit after taxes
Add back depreciation
Equipment purchases
Cash flow due to change in NOWC
Net cash flow due to salvage
Net Cash Flow (Time line of cash flows)
Key Results:Appraisal of the Proposed Project
Net Present Value (at 10%) =
IRR =
MIRR =
Payback =
Discounted Payback =
Data for Payback Years			Years
				0	1	2	3	4
			Net cash flow
			Cumulative CF
			Part of year requiredfor payback
Data for Discounted Payback Years		Years
				0	1	2	3	4
			Net cash flow	$0	$0	$0	$0	$0
			Discounted cash flow
			Cumulative CF
			Part of year required for discounted payback
b.Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and number of units sold.Set these variables' values at 10% and 20% above and below their base-case values. Include a graph in your analysis.
% Deviation	1st YEAR UNIT SALES		Note about data tables.The data in the column input should NOT be input using a cell reference to the column input cell.For example, the base case 1st Year Unit Sales in Cell B100 should be the number 1,000 and NOT have the formula =D31 in that cell.This is because you'll use D31 as the column input cell in the data table and if Excel tries to iteratively replace Cell D31 with the formula =D31 rather than a series of numbers, Excel will calculate the wrong answer.Unfortunately, Excel won't tell you that there is a problem, so you'll just get the wrong values for the data table!
from	Base	NPV
Base Case	1,000	$0
-20%
-10%
0%
10%
20%
% Deviation	SALES PRICE		% Deviation	VARIABLE COST
from	Base	NPV		from	Base	NPV
Base Case	$24.00	$0		Base Case	$18.00	$0
-20%				-20%
-10%				-10%
0%				0%
10%				10%
20%				20%
	Deviation	NPV at Different Deviations from Base
	from		Sales	Variable
	Base Case	Units Sold	Price	Cost/Unit
	-20%	$0	$0	$0
	-10%	$0	$0	$0
	0%	$0	$0	$0
	10%	$0	$0	$0
	20%	$0	$0	$0
	Range	$0	$0	$0

d.If the project appears to be more or less risky than an average project, find its risk-adjusted NPV, IRR, and payback.CV range of firm's average-risk project:0.8to1.2Low-risk WACC =8%WACC =10%High-risk WACC =13%Risk-adjusted WACC =Risk adjusted NPV =IRR =Payback =e.On the basis of information in the problem, would you recommend that the project be accepted?