Lets return to the case involving Amazons project for the Cheetah router. Earlier in the semester, we estimated the cash flows, which is the first step in analyzing project. We now need to estimate Amazons cost of capital in order to continue our analysis of the project.

Use the 10-year Treasury Bond rate as the risk free rate and assume that the market risk premium is 6.5% to find Amazons cost of equity. Assume that Amazons bonds are rated AAA and that Amazons corporate tax rate is 21%. Assume that Amazons bonds have no floatation costs, but the cost of issuing equity is 3.5%. Find Amazons weighted average cost of capital. Assume that the project will be financed with internal funds. You will need to find additional financial information from the Wall Street Journal and online at sites like http://finance.yahoo.comLinks to an external site. to complete your calculation.

Do this analysis in the same spreadsheet where you computed the operating cash flows for the project. Put the work in a separate tab.

Once you have completed the cost of capital calculations, return to the proforma income statement determine if the project is desirable or not.

Using the spreadsheet you previously constructed and the cost of capital calculations you computed, determine if Amazon should do the Cheetah project. Use the following capital budgeting techniques.

1. Payback period
2. Net present value
3. Internal rate of return

Now lets test the sensitivity of the project to some changes in the assumptions.

4. Take the cost of capital you previously computed (in week 8) and add 4% to the value (for example, if WACC was 12%, make it 16%) and recalculate NPV. What happens to IRR? Is the project still desirable?
5. Suppose the cost of goods sold percentage rises by 2.5%. Compute the payback period, NPV and IRR. Use the original WACC you computed.
6. How sensitive is NPV to the changes made in 4 and 5?

Below is the original project you were given earlier in the semester.

Suppose Amazon (ticker symbol - amzn) has decided to introduce a new high speed router, the Lightning. Before they launch the Lightning, they conducted an analysis to see if the Lightning would be a desirable investment. The company estimated that it would sell 25 million Lightings per year at a price of $450 for the next six years. After the first year of sales, the quantity sold will increase by 4% per year for the remaining life of the project. The initial capital outlay is determined to be $2.5 billion and a $750 million outlay in net working capital (NWC) would also be required. Assume that there is a one-time investment in NWC and that this will be recovered at the end of the project. Assume that the equipment used will be depreciated using the MACRS 7 year schedule and that the equipment has a salvage value of zero. At the end of year 6, the equipment will be sold for 150% of its book value. Also, assume that that the tax rate is 25%.

Using information from Amazons financial statements (you may want to use Morningstar.com or some other online site) estimate the operating cash flows from the project. Make any simplifying assumptions that are necessary to produce the estimate.