Start with the partial model in the file Ch11 P18 Build a Model.xlsx on the textbooks

Web site. 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 years

projected sales; for example, NWC0 5 10%(Sales1). The servers would sell for $24,000

per unit, and Webmasters believes that variable costs would amount to $18,000 per

unit. After Year 1, the sales price and variable costs will increase at the inflation rate

of 3%. The companys 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. Also, the projects returns are expected to be highly correlated

with returns on the firms other assets. The firm believes it could sell 1,000 units

per year.

The equipment would be depreciated over a 5-year period, using MACRS rates.

The estimated market value of the equipment at the end of the projects 4-year life is

$500,000. Webmasters.coms federal-plus-state tax rate is 25%. Its cost of capital is

10% for average-risk projects, defined as projects with a coefficient of variation of NPV

between 0.8 and 1.2. Low-risk projects are evaluated with an 8% project cost of capital

and high-risk projects at 13%.

a. Develop a spreadsheet model, and use it to find the projects NPV, IRR, and

payback.

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.

c. Now conduct a scenario analysis. Assume that there is a 25% probability that bestcase

conditions, with each of the 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.

d. If the project appears to be more or less risky than an average project, find its riskadjusted

NPV, IRR, and payback.

e. On the basis of information in the problem, would you recommend the project

should be accepted?