Chapter 8 Data Case

You have just been hired by Internal Business Machines Corporation (IBM) in their capital budgeting division. Your first assignment is to determine the free cash flows and NPV of a proposed new type of tablet computer similar in size to an iPad but with the operating power of a high-end desktop system.

Development of the new system will initially requirean initial capital expenditure equal to 10% of IBM's Net Property, Plant, and Equipment (PPE) at the end of the latest fiscal year for which data is available. The project will then require an additional investment equal to 10% of the initial investment after the first year of the project, a 5% increase after the second year, and a 1% increase after the third, fourth, and fifth years. The product is expected to have a life of five years. First-year revenues for the new product are expected to be3% of IBM's total revenue for the latest fiscal year for which data is available. The new product's revenues are expected to grow at 15% for the second year then 10% for the third and 5% annually for the final two years of the expected life of the project. Your job is to determine the rest of the cash flows associated with this project. Your boss has indicated that the operating costs and net working capital requirements are similar to the rest of the company (implying the project will have the same ratio of EBITDA to sales and working capital to sales) and that depreciation is straight-line (over 5 years) for capital budgeting purposes.

Since your boss hasn't been much help (welcome to the "real world"!), here are some tips to guide your analysis:

1. Obtain IBM's financial statements. (If you really worked for IBM you would already have this data, but at least you won't get fired if your analysis is off target.) Download the annual income statements, balance sheets, and cash flow statementsfor the last four fiscal years from Yahoo! Finance (finance.yahoo.com). Enter IBM's ticker symbol and then go to "financials."From the latest 10-K filing on SEC EDGAR (https://www.sec.gov/edgar/searchedgar/companysearch). Follow the steps shown in the Week 3 sync-up (3/4/2024).

2. You are now ready to estimate the Free Cash Flow for the new product. Compute the Free Cash Flow for each year using Eq. 8.5:

Free Cash Flow=(Revenues-Costs-Depreciation)*(1-tc) +Depreciation-CapEx-NWC

Set up the timeline and computation of free cash flow in separate, contiguous columns for each year of the project life. Be sure to make outflows negative and inflows positive.

a. Assume that the project's profitability will be similar to IBM's existing projects in the latest fiscal year and estimate (revenues-costs) each year by using the latest EBITDA/Sales profit margin.Currently, Yahoo reports EBITDA at the bottom of the income statement. Verify this number by EBITDA is calculated by adding Income Before Tax, Interest Expense, (from the income statement) and Depreciation & amortization (from the cash flow statement).If the two numbers are inconsistent, use the latter method to calculate EBITDA.

b. Determine the annual depreciation by assuming IBM depreciates these assets by the straightline method over a five-year life.

c. Determine IBM's tax rate by using the current U.S. federal corporate income tax rate (assume 26%).

d. Calculate the net working capital required each year by assuming that the level of NWC will be a constant percentage of the project's sales. Use IBM's NWC/Sales for the latest fiscal year to estimate the required percentage. (Use only accounts receivable, accounts payable, and inventory to measure working capital. Other components of current assets and liabilities are harder to interpret and not necessarily reflective of the project's required NWCfor example, IBM's cash holdings.)

e. To determine the free cash flow, deduct the additional capital investment and the change in net working capital each year.

3. Use Excel to determine the NPV of the project with a 12% cost of capital. Also calculate the IRR of the project using Excel's IRR function.

4. Perform a sensitivity analysis by varying the project forecasts as follows:

a. Suppose first year sales will equal 2%-4% of IBM's revenues.

b. Suppose the cost of capital is 10%-15%.

c. Suppose revenue growth is constant after the first year at a rate of 0%-10%.

CONSOLIDATED INCOME STATEMENT - USD ($) $ in Millions	12 Months Ended
Dec. 31, 2023	Dec. 31, 2022	Dec. 31, 2021				CONSOLIDATED BALANCE SHEET - USD ($) $ in Millions	Dec. 31, 2023	Dec. 31, 2022				CONSOLIDATED STATEMENT OF CASH FLOWS - USD ($) $ in Millions	12 Months Ended
Revenue	$ 61,860	$ 60,530		$ 57,350					Current assets						Dec. 31, 2023	Dec. 31, 2022	Dec. 31, 2021
Cost	27,560	27,842		25,865					Cash and cash equivalents	$ 13,068	$ 7,886				Cash flows from operating activities
Gross profit	34,300	32,687		31,486					Restricted cash	21	103				Net income		$ 7,502	$ 1,639	[1]	$ 5,743	[2]
Expense and other (income)									Marketable securities	373	852				Adjustments to reconcile net income to cash provided by operating activities
Selling, general and administrative	19,003	18,609		18,745					Notes and accounts receivabletrade (net of allowances of $192 in 2023 and $233 in 2022)	7,214	6,541				Pension settlement charge		0	5,894		0
Research, development and engineering	6,775	6,567		6,488					Short-term financing receivables						Depreciation	[3]	2,109	2,407		3,888
Intellectual property and custom development income	(860)	(663)		(612)					Held for investment (net of allowances of $129 in 2023 and $145 in 2022)	6,102	6,851				Amortization of capitalized software and acquired intangible assets		2,287	2,395		2,529
Other (income) and expense	(914)	5,803		873					Held for sale	692	939				Stock-based compensation		1,133	987		982
Interest expense	1,607	1,216		1,155					Other accounts receivable (net of allowances of $109 in 2023 and $89 in 2022)	640	817				Deferred taxes		(1,114)	(2,726)		(2,001)
Total expense and other (income)	25,610	31,531		26,649					Inventory	1,161	1,552				Net (gain)/loss on asset sales and other	[4]	(170)	(363)		(136)
Income from continuing operations before income taxes	8,690	1,156		4,837					Deferred costs	998	967				Change in operating assets and liabilities, net of acquisitions/divestitures
Provision for/(benefit from) income taxes	1,176	(626)		124					Prepaid expenses and other current assets	2,639	2,611				Receivables (including financing receivables)		725	(539)		1,372
Income from continuing operations	7,514	1,783		4,712					Total current assets	32,908	29,118				Retirement related		(462)	331		1,038
Income/(loss) from discontinued operations, net of tax	(12)	(143)		1,030					Property, plant and equipment	18,122	18,695				Inventory		390	71		138
Net income	$ 7,502	$ 1,639	[1]	$ 5,743	[2]				Less: Accumulated depreciation	12,621	13,361				Other assets/other liabilities	[4]	1,466	126		(842)
Assuming dilution									Property, plant and equipmentnet	5,501	5,334				Accounts payable		65	213		85
Continuing operations (in dollars per share)	$ 8.15	$ 1.95		$ 5.21					Operating right-of-use assetsnet	3,220	2,878				Net cash provided by operating activities		13,931	10,435		12,796
Discontinued operations (in dollars per share)	(0.01)	(0.16)		1.14					Long-term financing receivables (net of allowances of $27 in 2023 and $28 in 2022)	5,766	5,806				Cash flows from investing activities
Total (in dollars per share)	8.14	1.80		6.35					Prepaid pension assets	7,506	8,236				Payments for property, plant and equipment		(1,245)	(1,346)		(2,062)
Basic									Deferred costs	842	866				Proceeds from disposition of property, plant and equipment		321	111		387
Continuing operations (in dollars per share)	8.25	1.97		5.26					Deferred taxes	6,656	6,256				Investment in software		(565)	(626)		(706)
Discontinued operations (in dollars per share)	(0.01)	(0.16)		1.15					Goodwill	60,178	55,949				Purchases of marketable securities and other investments		(11,143)	(5,930)		(3,561)
Total (in dollars per share)	$ 8.23	$ 1.82		$ 6.41					Intangible assetsnet	11,036	11,184				Proceeds from disposition of marketable securities and other investments		10,647	4,665		3,147
Weighted-average number of common shares outstanding									Investments and sundry assets	1,626	1,617				Acquisition of businesses, net of cash acquired		(5,082)	(2,348)		(3,293)
Assuming dilution (in shares)	############	############		############					Total assets	135,241	127,243				Divestiture of businesses, net of cash transferred		(4)	1,272		114
Basic (in shares)	############	############		############					Current liabilities						Net cash provided by/(used in) investing activities		(7,070)	(4,202)		(5,975)
Services									Taxes	2,270	2,196				Cash flows from financing activities
Revenue	$ 30,378	$ 30,206		$ 29,225					Short-term debt	6,426	4,760				Proceeds from new debt		9,586	7,804		522
Cost	21,051	21,062		19,147					Accounts payable	4,132	4,051				Payments to settle debt		(5,082)	(6,800)		(8,597)
Sales									Compensation and benefits	3,501	3,481				Short-term borrowings/(repayments) less than 90 daysnet		(7)	217		(40)
Revenue	30,745	29,673		27,346					Deferred income	13,451	12,032				Common stock repurchases for tax withholdings		(402)	(407)		(319)
Cost	6,127	6,374		6,184					Operating lease liabilities	820	874				Financingother		176	176		70
Financing									Other accrued expenses and liabilities	3,521	4,111				Distribution from Kyndryl		0	0		879	[5]
Revenue	737	651		780					Total current liabilities	34,122	31,505				Cash dividends paid		(6,040)	(5,948)		(5,869)
Cost	$ 382	$ 406		$ 534					Long-term debt	50,121	46,189				Net cash provided by/(used in) financing activities		(1,769)	(4,958)		(13,354)
									Retirement and nonpension postretirement benefit obligations	10,808	9,596				Effect of exchange rate changes on cash, cash equivalents and restricted cash		9	(244)		(185)
									Deferred income	3,533	3,499				Net change in cash, cash equivalents and restricted cash		5,101	1,032		(6,718)
									Operating lease liabilities	2,568	2,190				Cash, cash equivalents and restricted cash at January 1		7,988	6,957		13,675
									Other liabilities	11,475	12,243				Cash, cash equivalents and restricted cash at December 31		13,089	7,988		6,957
									Total liabilities	112,628	105,222				Supplemental data
									Commitments and Contingencies						Income taxes paidnet of refunds received		1,564	1,865		2,103
									IBM stockholders' equity						Interest paid on debt		$ 1,668	$ 1,401		$ 1,512
									Common stock	59,643	58,343
									Retained earnings	151,276	149,825
									Treasury stock, at cost (shares: 20231,351,897,514; 20221,351,024,943)	(169,624)	(169,484)
									Accumulated other comprehensive income/(loss)	(18,761)	(16,740)
									Total IBM stockholders' equity	22,533	21,944
									Noncontrolling interests	80	77
									Total equity	22,613	22,021
									Total liabilities and equity	$ 135,241	$ 127,243