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Assignment $4.$xIsx

$4/16/10$

Assignment

Webmasters.com has developed a powerful new server that would be used for corporations' Internet activities. It would cost $$10$ million at Year $0$ to buy the equipment necessary to manufacture the server. The project would require net working capital at the beginning of each year in an amount equal to $10\%$ of the year's projected sales; for example, $NWC0=10\%(Sales1).$ The servers would sell for $$24,000$ per unit, and Webmasters believes that variable costs would amount to $$17,500$ per unit. After Year $1,$ the sales price and variable costs will increase at the inflation rate of $3\%.$ The company's nonvariable costs would be $$1$ million at Year $1$ and would increase with inflation.

The server project would have a life of $4$ years. If the project is undertaken, it must be continued for the entire $4$ years. Also, the project's returns are expected to be highly correlated with returns on the firm's other assets. The firm believes it could sell $1,000$ units per year.

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 $40\%.$ Its cost of capital is $10\%$ for average$-$risk projects, defined as projects with a coefficient of variation of NPV between $0\mathrm{.}8$ and $1\mathrm{.}2.$ Low$-$risk projects are evaluated with a WACC of $8\%,$ and high$-$risk projects at $13\%.$