4 5 Webmasters.com has developed a powerful new server that would be used for corporations' Internet activities. It would 6 cost $10 million at Year 0 to buy the equipment necessary to manufacture the server. The project would require net 7 working capital at the beginning of each year in an amount equal to 10% of the year's projected sales; for example, NWC, 8 = 10%(Sales). 9 10 The firm believes it could sell 1,000 units per year. The servers would sell for $24,000 per unit, and Webmasters believes that 11 variable costs would amount to $18,000 per unit. After Year 1, the sales price and variable costs will increase at the inflation 12 rate of 3%. The company's nonvariable costs would be $1 million at Year 1 and also would increase at the 3% inflation rate. 13 14 15 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 16 equipment would be depreciated over a 5-year period, using MACRS rates. The estimated market value of the equipment 17 at the end of the project's 4-year life is $500,000. 18 19 Webmasters' federal-plus-state tax rate is 25%. Its cost of capital is 10% for average-risk projects, defined as projects 20 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- 21 risk projects at 13%. Also, the project's returns are expected to be highly correlated with returns on the firm's other assets. 22 23 24 a. Develop a spreadsheet model, and use it to find the project's NPV, IRR, and payback. 25 26 Input Data (in thousands of dollars) 27 Scenario name Base Case Note: the items in red will be used in a scenario analysis. 28 Probability of scenario 50% 29 Equipment cost $10,000 30 Net operating working capital/Sales 10% Key Results: 31 First year sales (in units) 1,000 NPV = $0 32 Sales price per unit $24.00) IRR 0.0% 33 Variable cost per unit (excl. depr.) $18.00 Payback = 0.00 34 Nonvariable costs (excl. depr.) $1,000 35 Inflation in prices and costs 3.0% 36 Estimated salvage value at year 4 $500 37 Depreciation years Year 1 Year 2 Year 3 Year 4 38 Depreciation rates 20.00% 32.00% 19.20% 11.52% 39 Tax rate 25% 40 WACC for average-risk projects 10% 41 0 1 2 3 4 20.00% 32.00% 19.20% 11.52% Years 2 0 1 3 41 42 Intermediate Calculations 43 Units sold 44 Sales price per unit (excl. depr.) 45 Variable costs per unit (excl. depr.) 46 Nonvariable costs (excl. depr.) 47 Sales revenue 48 Required level of net operating working capital 49 Basis for depreciation 50 Annual equipment depr. rate 51 Annual depreciation expense 52 Ending Bk Val: Cost - Accum Dep'rn 53 Salvage value 54 Profit (or loss) on salvage 55 Tax on profit (or loss) 56 Net cash flow due to salvage 57 58 Cash Flow Forecast 59 Sales revenue 60 Variable costs 61 Nonvariable operating costs 62 Depreciation (equipment) 63 Oper. income before taxes (EBIT) 64 Taxes on operating income (40% 65 Net operating profit after taxes 66 Add back depreciation 67 Equipment purchases 68 Cash flow due to change in NOWC 69 Net cash flow due to salvage 70 Net Cash Flow (Time line of cash flows) 71 72 Key Results: Appraisal of the Proposed Project 73 74 Net Present Value (at 10%) = 75 IRR = 76 MIRR = 77 Payback = 78 Discounted Payback = 79 Data for Payback Years 80 81 Net cash flow 82 Cumulative CF 83 Part of year required for payback 84 85 86 Data for Discounted Payback Years 87 88 Net cash flow 89 Discounted cash flow 90 Cumulative CF 91 Part of year required for discounted payback 92 Years 2 0 1 3 4 0 $0 4 Years 2. $0 1 $0 3 $0 $0 10% 94 b. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, 95 and number of units sold. Set these variables' values at 10% and 20% above and below their base-case values. Include a graph 96 in your analysis. 97 98 % Deviation 1st YEAR UNIT SALES 99 from Base NPV Note about data tables. The data in the column input should NOT be 100 Base Case 1,000 $0 input using a cell reference to the column input cell. For example, the 101 -20% 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 102 -10% you'll use D31 as the column input cell in the data table and if Excel 103 0% tries to iteratively replace Cell D31 with the formula =D31 rather than a 104 10% series of numbers, Excel will calculate the wrong answer. 105 20% Unfortunately, Excel won't tell you that there is a problem, so you'll 106 just get the wrong values for the data table! 107 108 109 % Deviation SALES PRICE % Deviation VARIABLE COST 110 from Base NPV from Base NPV 111 Base Case $24.00 $0 Base Case $18.00 $0 112 -20% -20% 113) -10% -10% 114 0% 0% 115 10% 116 20% 20% 117 118 119 120 121 122 123 124 125 126 127 128 129 130 131 132 133 134 135 136 137 138 139 140 141 Deviation NPV at Different Deviations from Base 142 from Sales Variable 143 Base Case Units Sold Price Cost/Unit 144 -20% $0 $0 $0 145 -10% $0 $0 $0 146 0% $0 $0 $0 147 10% $0 $0 $0 148 20% $0 $0 $0 149 150 Range $0 $0 $0 151 152 ura 154 152 153 c. Now conduct a scenario analysis. Assume that there is a 25% probability that best-case conditions, with each of the variables discussed in Part b being 20% better than its base-case value, will occur. There is a 25% probability of worst-case conditions, 155 156 with the variables 20% worse than base, and a 50% probability of base-case conditions. (Hint: Use Scenario Manager. Go to the Data menu, choose What-lf-Analyis, the choose Scenario Manager. After you create the Scenario's, you can pick a scenario and 157 158 type in the resulting NPV (but be sure to return the Scenario to the base-case afterward). Or you can create a Scenario Summary and use a cell reference to the Scenario Summary worksheet to show the NPV for each scenario.) 159 Sales Price per Unit Variable Costs per Unit Scenario Probability Unit Sales NPV 160 161 162 163 164 165 166 167 168 169 170 171 172 Best Case Base Case Worst Case 25% 50% 25% 1,200 1,000 800 $28.80 $24.00 $19.20 $14.40 $18.00 $17.28 Expected NPV Standard Deviation = Coefficient of Variation = Std Dev / Expected NPV = 4 5 Webmasters.com has developed a powerful new server that would be used for corporations' Internet activities. It would 6 cost $10 million at Year 0 to buy the equipment necessary to manufacture the server. The project would require net 7 working capital at the beginning of each year in an amount equal to 10% of the year's projected sales; for example, NWC, 8 = 10%(Sales). 9 10 The firm believes it could sell 1,000 units per year. The servers would sell for $24,000 per unit, and Webmasters believes that 11 variable costs would amount to $18,000 per unit. After Year 1, the sales price and variable costs will increase at the inflation 12 rate of 3%. The company's nonvariable costs would be $1 million at Year 1 and also would increase at the 3% inflation rate. 13 14 15 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 16 equipment would be depreciated over a 5-year period, using MACRS rates. The estimated market value of the equipment 17 at the end of the project's 4-year life is $500,000. 18 19 Webmasters' federal-plus-state tax rate is 25%. Its cost of capital is 10% for average-risk projects, defined as projects 20 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- 21 risk projects at 13%. Also, the project's returns are expected to be highly correlated with returns on the firm's other assets. 22 23 24 a. Develop a spreadsheet model, and use it to find the project's NPV, IRR, and payback. 25 26 Input Data (in thousands of dollars) 27 Scenario name Base Case Note: the items in red will be used in a scenario analysis. 28 Probability of scenario 50% 29 Equipment cost $10,000 30 Net operating working capital/Sales 10% Key Results: 31 First year sales (in units) 1,000 NPV = $0 32 Sales price per unit $24.00) IRR 0.0% 33 Variable cost per unit (excl. depr.) $18.00 Payback = 0.00 34 Nonvariable costs (excl. depr.) $1,000 35 Inflation in prices and costs 3.0% 36 Estimated salvage value at year 4 $500 37 Depreciation years Year 1 Year 2 Year 3 Year 4 38 Depreciation rates 20.00% 32.00% 19.20% 11.52% 39 Tax rate 25% 40 WACC for average-risk projects 10% 41 0 1 2 3 4 20.00% 32.00% 19.20% 11.52% Years 2 0 1 3 41 42 Intermediate Calculations 43 Units sold 44 Sales price per unit (excl. depr.) 45 Variable costs per unit (excl. depr.) 46 Nonvariable costs (excl. depr.) 47 Sales revenue 48 Required level of net operating working capital 49 Basis for depreciation 50 Annual equipment depr. rate 51 Annual depreciation expense 52 Ending Bk Val: Cost - Accum Dep'rn 53 Salvage value 54 Profit (or loss) on salvage 55 Tax on profit (or loss) 56 Net cash flow due to salvage 57 58 Cash Flow Forecast 59 Sales revenue 60 Variable costs 61 Nonvariable operating costs 62 Depreciation (equipment) 63 Oper. income before taxes (EBIT) 64 Taxes on operating income (40% 65 Net operating profit after taxes 66 Add back depreciation 67 Equipment purchases 68 Cash flow due to change in NOWC 69 Net cash flow due to salvage 70 Net Cash Flow (Time line of cash flows) 71 72 Key Results: Appraisal of the Proposed Project 73 74 Net Present Value (at 10%) = 75 IRR = 76 MIRR = 77 Payback = 78 Discounted Payback = 79 Data for Payback Years 80 81 Net cash flow 82 Cumulative CF 83 Part of year required for payback 84 85 86 Data for Discounted Payback Years 87 88 Net cash flow 89 Discounted cash flow 90 Cumulative CF 91 Part of year required for discounted payback 92 Years 2 0 1 3 4 0 $0 4 Years 2. $0 1 $0 3 $0 $0 10% 94 b. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, 95 and number of units sold. Set these variables' values at 10% and 20% above and below their base-case values. Include a graph 96 in your analysis. 97 98 % Deviation 1st YEAR UNIT SALES 99 from Base NPV Note about data tables. The data in the column input should NOT be 100 Base Case 1,000 $0 input using a cell reference to the column input cell. For example, the 101 -20% 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 102 -10% you'll use D31 as the column input cell in the data table and if Excel 103 0% tries to iteratively replace Cell D31 with the formula =D31 rather than a 104 10% series of numbers, Excel will calculate the wrong answer. 105 20% Unfortunately, Excel won't tell you that there is a problem, so you'll 106 just get the wrong values for the data table! 107 108 109 % Deviation SALES PRICE % Deviation VARIABLE COST 110 from Base NPV from Base NPV 111 Base Case $24.00 $0 Base Case $18.00 $0 112 -20% -20% 113) -10% -10% 114 0% 0% 115 10% 116 20% 20% 117 118 119 120 121 122 123 124 125 126 127 128 129 130 131 132 133 134 135 136 137 138 139 140 141 Deviation NPV at Different Deviations from Base 142 from Sales Variable 143 Base Case Units Sold Price Cost/Unit 144 -20% $0 $0 $0 145 -10% $0 $0 $0 146 0% $0 $0 $0 147 10% $0 $0 $0 148 20% $0 $0 $0 149 150 Range $0 $0 $0 151 152 ura 154 152 153 c. Now conduct a scenario analysis. Assume that there is a 25% probability that best-case conditions, with each of the variables discussed in Part b being 20% better than its base-case value, will occur. There is a 25% probability of worst-case conditions, 155 156 with the variables 20% worse than base, and a 50% probability of base-case conditions. (Hint: Use Scenario Manager. Go to the Data menu, choose What-lf-Analyis, the choose Scenario Manager. After you create the Scenario's, you can pick a scenario and 157 158 type in the resulting NPV (but be sure to return the Scenario to the base-case afterward). Or you can create a Scenario Summary and use a cell reference to the Scenario Summary worksheet to show the NPV for each scenario.) 159 Sales Price per Unit Variable Costs per Unit Scenario Probability Unit Sales NPV 160 161 162 163 164 165 166 167 168 169 170 171 172 Best Case Base Case Worst Case 25% 50% 25% 1,200 1,000 800 $28.80 $24.00 $19.20 $14.40 $18.00 $17.28 Expected NPV Standard Deviation = Coefficient of Variation = Std Dev / Expected NPV =