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, NWC0 = 10%(Sales1). 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 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 project's returns are expected to be highly correlated with returns on the firm's 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 federal-plus-state tax rate is 40%. 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 a WACC of 8%, and high-risk projects at 13%.

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

Input Data (in thousands of dollars)

Equipment cost

$10,000

Key Results:

Net operating working capital/Sales

10%

NPV =

First year sales (in units)

1,000

IRR =

Sales price per unit

$24.00

Payback =

Variable cost per unit (excl. depr.)

$17.50

Nonvariable costs (excl. depr.)

$1,000

Market value of equipment at Year 4

$500

Tax rate

40%

WACC

10%

Inflation in prices and costs

3.0%

Estimated salvage value at year 4

$500