Problem 2:

Microsoft Corporation (NASDAQ: MSFT) wants to develop a new limited edition game controller for its Xbox Series X.

• Each controller is expected to sell at $65.
• MSFT plans to sell 3,000,000 per year.
• The cost of producing one controller is $18.
• The project requires an R&D of $300M and the lease of a new space for $1.5M per year
• The project requires the investment in Capex of $85 M
• The depreciation of the equipment is over 3 three years in a straight-line method.
• The corporate tax rate is 29%.
• The discount rate is 13%.

1. Compute the FCF for years 0-5
2. Compute the continuation value of the FCF from year 6 onwards in time and value of money of year 5.
3. Using the terminal value in b), compute the NPV of the project.
4. Compute the payback period

MSFT wants to reduce its taxable income using the loss on year 0. To this end, the company implements a tax loss carryforward strategy.

1. What is the highest tax loss carryforward MSFT can claim in year 1? What is the taxable income (after the carryforward) for year 1? (Hint: pre-tax income=EBIT)
2. How many years can MSFT use the loss carryforward?

MSFT now wants to see if the NPV of the project can be affected by the depreciation method. MSFT is considering to use an accelerated depreciation method. That is, under this option, MSFT can depreciate the assets in the following schedule: 50% in the first year, 33% in the second, and 17% in the third year.

1. Compute the FCF and NPV under this new depreciation method.
2. Does it make financial sense for MSFT to change the depreciation method? Discuss.
3. What if the depreciation schedule is more steep: 70% in year 1, 20% in year 2 and 10% in year 3. Compute the FCF and NPV. Does it benefit the firm?