Question #1:

IBM is considering a new expansion project and the finance staff has received information summarized below.

• The project require IBM to purchase $900,000 of equipment in 2013 (t=0).
• Account Receivables will increase by $100,000
• Cash will increase by $75,000
• Accruals will rise by $25,000.
• Notes payable will increase by $50,000
• The project will last for four years. The company forecasts that they will sell 2,685,000 units in 2014, 2,600,000 units in 2015, 2,525,000 units in 2016, and 2,450,000 units in 2017. Each unit will sell for $2.
• The fixed cost of producing the product is $2 million each year.
• The variable cost of producing each unit will rise from $1.018, 1.078, 1.046 and $1.221 from 2013 to 2017 respectively.
• The equipment will be depreciated under the MACRS system using the applicable rates of 33%, 45%, 15%, and 7% respectively
• When the project is completed in 2017 (t=4), the company expects that it will be able to salvage the equipment for $50,000
• They expect to fully recover the NWC.
• The estimated tax rate is 35%.
• Based on the perceived risk, the projects WACC is estimated to be 10%.

Your main task is to and evaluate the cash flows, analyze the results, and present your recommendations. To help in the analysis, answer all the following questions:

1 What is the total equipment cost? ___________________

2 What is the Net Working Capital (NWC)?

Hint: NWC = Current Assets Current Liabilities

3 What is the total investment amount at the start of the project (i.e. year zero cash flow)?

4 What is the depreciation amount for each year?

List accounts in this column.	Year 1	2	3	4

5 Calculate the book values for each year?

List accounts in this column.	Year 1	2	3	4

6 Calculate the after-tax salvage value

Hint: After-tax salvage value

= Salvage Value Tax on Gain

=Salvage Value ((Tax * ( Salvage Value Book Value))

7 Compute the Net Income during the projects life for each year.

1. You must list all the accounts and entries in order to earn full credit. No credit will be awarded for merely listing numbers without the associated accounts.
2. Show the work in order to full credit

List accounts in this column.	Year 1	2	3	4

8 Calculate the Operating Cash Flows (OCF) for each year.

List accounts in this column.	Year 1	2	3	4

9 Create the projected Free Cash Flow Schedule for the project:

Projected Free Cash Flow Schedule

Year 0 Year 1 Year 2 Year 3 Year 4

OCF₁ OCF₂ OCF₃ OCF₄

• Equipment cost +After tax Salvage Value
• Net Working Capital + Net Working Capital

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Total Free Cash Flows

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10 Calculate the Net Present Value (NPV)

a) Timeline Solution

b) Cash flow keys. List the keys and entries

11 Interpret the NPV

12 Should the project be accepted or rejected based on the NPV? Explain

13 Calculate the IRR using Cash Flow keys. List the keys and entries

14 Interpret the IRR

15 Should the project be accepted or rejected based on the IRR? Explain

16 Present this project to board of trustees and make a case why it should be undertaken or not undertaken.

17 What is using an accurate WACC important in capital budgeting?