OFF STATCHAP 11 PROB 18 TEMPLATEOFF STAT21/06/2014
Chapter:11
Problem:18
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 costKey Results:
Net operating working capital/SalesNPV =$0
First year sales (in units)IRR =#NUM!
Sales price per unitPayback =0.00
Variable cost per unit (excl. depr.)
Nonvariable costs (excl. depr.)
Market value of equipment at Year 4
Tax rate
WACC
Inflation in prices and costs
Estimated salvage value at year 4
Intermediate Calculations01234
Units sold0000
Sales price per unit (excl. depr.)$0.00$0.00$0.00$0.00
Variable costs per unit (excl. depr.)$0.00$0.00$0.00$0.00
Nonvariable costs (excl. depr.)0000
Sales revenue$0$0$0$0
Required level of net operating working capital$0$0$0$0$0
Basis for depreciation$0
Annual equipment depr. rate
Annual depreciation expense$0$0$0$0
Ending Bk Val: Cost Accum Dep’rn$0$0$0$0$0
Salvage value$0
Profit (or loss) on salvage$0
Tax on profit (or loss)$0
Net cash flow due to salvage$0
Years
Cash Flow Forecast01234
Sales revenue$0$0$0$0
Variable costs0000
Nonvariable operating costs0000
Depreciation (equipment)0000
Oper. income before taxes (EBIT)$0$0$0$0
Taxes on operating income (40%)0000
Net operating profit after taxes$0$0$0$0
Add back depreciation0000
Equipment purchases$0
Cash flow due to change in NOWC$0$0$0$0$0
Net cash flow due to salvage$0
Net Cash Flow (Time line of cash flows)$0$0$0$0$0
Key Results: Appraisal of the Proposed Project
Net Present Value (at 10%) =$0
IRR =#NUM!
MIRR =#DIV/0!
Payback =0.00
Data for Payback YearsYears
01234
Net cash flow$0$0$0$0$0
Cumulative CF$0$0$0$0$0
Part of year required for payback0.000.000.000.00
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.
% DeviationSALES PRICENote about data tables. The data in the column input should NOT be input using a cell reference to the column input cell. For example, the base case Sales Price in Cell B86 should be the number $24.00 you should NOT have the formula =D28 in that cell. This is because you’ll use D28 as the column input cell in the data table and if Excel tries to iteratively replace Cell D28 with the formula =D28 rather than a series of numbers, Excel will calculate the wrong answer. Unfortunately, Excel won’t tell you that there is a problem, so you’ll just get the wrong values for the data table!
fromBaseNPV
Base Case$24.00$0
-20%$19.20$0
-10%$21.60$0
0%$24.00$0
10%$26.40$0
20%$28.80$0
% DeviationVARIABLE COST% Deviation1st YEAR UNIT SALES
fromBaseNPVfromBaseNPV
Base Case$17.50$0Base Case1,000$0
-20%$14.00$0-20%800$0
-10%$15.75$0-10%900$0
0%$17.50$00%1,000$0
10%$19.25$010%1,100$0
20%$21.00$020%1,200$0