07 Jun The following question can be found attached to the file below.
Question
The following question can be found attached to the file below.
12/7/2012
Chapter:
Problem:
11
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 company’s 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 project’s 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 project’s NPV, IRR, and payback.
Input Data (in thousands of dollars)
Equipment cost
Net operating working capital/Sales
First year sales (in units)
Sales price per unit
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
$10,000
10%
1,000
$24.00
$17.50
$1,000
$500
40%
10%
3.0%
$500
Intermediate Calculations
Units sold
Sales price per unit (excl. depr.)
Variable costs per unit (excl. depr.)
Nonvariable costs (excl. depr.)
Sales revenue
Required level of net operating working capital
Basis for depreciation
Annual equipment depr. rate
Annual depreciation expense
Ending Bk Val: Cost – Accum Dep’rn
Salvage value
Profit (or loss) on salvage
Tax on profit (or loss)
Net cash flow due to salvage
Key Results:
NPV =
IRR =
Payback =
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