5 A B D E F G H 6 7 8 9 10 11 12 13 14 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, NWC = 10% (Sales). 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. 15 Also, the project's returns are expected to be highly correlated with returns on the firm's other assets. The firm believes it 16 could sell 1,000 units per year. 17 18 19 20 21 22 The equipment would be depreciated over a 5-year period, using MACRS rates. The depreciation rates for a 5-year MACRS asset are: 20%, 32%, 19.20% and 11.52%. 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%. 23 a. Develop a spreadsheet model, and use it to find the project's NPV, IRR, and payback. (50 points) 24 25 Input Data (in thousands of dollars) 26 Equipment cost 27 Net operating working capital/Sales $10,000 10% 28 First year sales (in units) 1,000 IRR = 29 Sales price per unit $24.00 Key Results: NPV = $3,463 21.1% Payback = 2.90 30 Variable cost per unit $17.50 31 Nonvariable costs $1,000 32 Market value of equipment at Year 4 $500 33 Tax rate 40% 34 WACC 10% 35 Inflation in prices and costs 3.0% 36 Estimated salvage value at year 4 $500 37 39 Units sold 38 Intermediate Calculations 40 Sales price per unit 41 Variable costs per unit 42 Nonvariable costs 43 Sales revenue 0 1 2 3 4 1,000 1,000 1,000 1,000 $24.00 $24.72 $25.46 $26.23 $17.50 $18.03 $18.57 $19.12 $1,000 $1,030 $1,061 $1,093 $0 $24,000 $24,720 $25,462 $26,225 J K A 44 Required level of net operating working capital 45 Basis for depreciation 46 Annual equipment depr. rate 47 Annual depreciation expense 48 Ending Bk Val: Cost - Accum Dep'rn 49 Salvage value 50 Profit (or loss) on salvage 51 Tax on profit (or loss) 52 Net cash flow due to salvage 53 54 Cash Flow Forecast 55 Sales revenue 56 Variable costs 57 Nonvariable costs 58 Depreciation (equipment) 59 Oper. income before taxes (EBIT) 60 Taxes on operating income (40%) 61 EBIT (1-T) 62 Add back depreciation 63 Net Operating CF D E F G H J K $2,400 $2,472 $2,546.16 $2,622.54 $0.00 $10,000 20.00% 32.00% 19.20% 11.52% $2,000 $3,200 $1,920 $1,152 $10,000 $8,000 $4,800 $2,880 $1,728 $500 -$1,228 -$491.20 $991 $24,000 $24,720 $25,462 $26,225 17,500 18,025 18,566 19,123 1,000 1,030 1,061 1,093 $2,000 $3,200 $1,920 $1,152 $3,500 $2,465 $3,915 $4,858 1,400 986 1,566 1,943 $2,100 $1,479 $2,349 $2,915 2,000 3,200 1,920 1,152 4,100 4,679 4,269 4,067 64 Projected Net Cash Flows 65 Equipment purchases (Initial Investment) -$10,000 66 Net Operating CF $4,100 $4,679 $4,269 $4,067 67 Cash flow due to change in NOWC -$2,400 -$72 -$74 -$76 $2,623 68 Net cash flow due to salvage $991 -$12,400 $4,028 $4,605 $4,193 $7,681 69 Net Cash Flow (Time line of cash flows) 70 71 Key Results: Appraisal of the Proposed Project 72 73 Net Present Value (at 10%) = 74 IRR = 75 MIRR= 76 Payback= 77 78 Data for Payback Years 79 80 81 82 83 $3,463 21.09% 16.99% 2.90 Net cash flow Cumulative CF -$12,400 $4,028 -$12,400 -$8,372 $4,605 -$3,767 $4,193 $425 Part of year required for payback 1.00 1.00 0.90 $7,681 $8,106 0.00 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. (15 points for S.A./ 5 points for graph) % Deviation from SALES PRICE Base Base Case $24.00 NPV $3,463 -20% $19.20 -10% $21.60 Please fit a graph in the yellow box below 0% $24.00 $3,463 10% $26.40 20% $28.80 % Deviation VARIABLE COST NPV % Deviation from Base Case 1st YEAR UNIT SALES Base 1,000 NPV -20% 800 -10% 900 0% 1,000 $3,463 10% 1,100 20% 1,200 from Base Base Case $17.50 -20% $14.00 -10% $15.75 0% $17.50 $3,463 10% $19.25 20% $21.00 E F G H J A B 134 Deviation NPV at Different Deviations from Base 135 from Sales Variable 136 Base Case Price Cost/Unit Units Sold 137 -20% $0 $0 $0 138 -10% $0 $0 $0 139 0% $3,463 $3,463 $3,463 140 10% $0 $0 $0 141 20% $0 $0 $0 142 143 Range 144 145 146 c. Now conduct a scenario analysis. Assume that there is a 25% probability that best-case conditions, with each of the 147 variables discussed in Part b being 20% better than its base-case value, will occur. There is a 25% probability of worst-case conditions, with the variables 20% worse than base, and a 50% probability of base-case conditions. (15 points) 148 149 150 151 152 Sales Unit 153 Scenario Probability Price Sales Variable Costs NPV 154 155 Best Case 25% $28.80 1,200 $14.00 156 Base Case 50% $24.00 1,000 $17.50 157 Worst Case 25% $19.20 800 $21.00 158 159 Expected NPV 160 Standard Deviation = 161 162 Coefficient of Variation = Std Dev / Expected NPV = d. Would you recommend that the project be accepted? Please carefully answer the question based on NPV, IRR, and Payback periods evaluation methods. In addition, you need to conclude from Sensitivity Analysis and Scenario Analysis to 163 justify your decisions. (15 points) 164 165 166