5. Forecast the projects cash flows for the next eight years. What assumptions did you use? Use MACRS depreciation for this case.

6. Use the appropriate capital budgeting techniques to evaluate the project.

7. Use the average demand scenario to evaluate the sensitivity of the projects NPV with respect to sale price of the high-efficiency printers and the cost of the print head.

8. Based on the scenario and sensitivity analysis you performed above, comment on the overall riskiness of the project.

Exhibit 1 Sales forecasts:

The forecasts are based on projected levels of demand. The firm could face weak, average, and strong demand. All the numbers are expressed in todays dollars. The forecasted average inflation per year is 3.0%.

Demand level	Weak	Average	Strong
Probability	25%	45%	30%
Price per high-efficiency printers	$90	$95	$97
Units sold per year	400,000	425,000	450,000
Labor cost per high-efficiency printers	$18
Parts	$7
Selling General & Administrative	$10,000,000
Average warranty cost per year per high-efficiency printers for the first five years is $5. The present value of this cost will be used as a cost figure for each high-efficiency printers. Afterwards, the high-efficiency printers owners will become responsible the repairs.
The high-efficiency printers can be produced for eight years. Afterwards, the designs become obsolete.

Exhibit 2 Print head costs:

Print head choices:

Print head model number	PC - 004	TP - L12
Price per print head and installation	$10	$6
Average annual warranty cost per year for five years. Afterwards, the high-efficiency printers owner will become responsible the repairs*.	$1	$2
The chosen print head will be installed in every high-efficiency printers and will become a cost figure for each unit produced. * The print head manufacturers are not providing Business Machines with any warranty. However, Business Machines will provide warranty to its customers. After the initial five years, the high-efficiency printers owners may purchase extended warranty from any insurance company that offers such packages.

Exhibit 3 Investment needs:

To implement the project, the firm has to invest funds as shown in the following table:

Year 0	Year 1
$14 million	Production and selling of commercial appliances starts

MACRS depreciation will be used.

To facilitate the operation of manufacturing the high-efficiency printers, the company will have to allocate funds to net working capital (NWC) equivalent to 10% of annual sales. The investment in NWC will be recovered at the end of the project.

Exhibit 4 Financing

The following assumptions are used to determine the cost of capital. Historically, the company tried to maintain a debt to equity ratio equal to 0.50. This ratio was used because lowering the debt implies giving up the debt tax shield and increasing it makes debt service a burden on the firms cash flow. In addition, increasing the debt level may cause a reduced rating of the companys bonds. The marginal tax rate is 35%. All the numbers are expressed in todays dollars. The forecasted average inflation per year is 3.0%.

Cost of debt:

The companys bond rating is roughly at the high end of the A range. Surveying the debt market yielded the following information about the cost of debt for different rating levels:

Bond rating	AA	A	BBB
Interest cost range	4.5% ~ 6.0%	5.75% ~ 7.5%	7.5% ~ 9%

The companys current bonds have a rating of AA.

Cost of equity:

The current 10-year Treasury notes have a yield to maturity of 3% and the forecast for the S&P 500 market premium is 6.5%. The companys overall b is 1.0.

b analysis: The company was able to develop a list of printer manufacturers, but had a list of appliances manufacturers.

Company	Business Machines	Electrics Plus	General Offsets	Universal Publishing Equipment	Stevenson, Inc.	International Paper Offset
Over all b	1.0	1.4	1.3	1.6	1.2	1.35
Debt to equity	0.5	0.3	0.5	0.45	0.35	0.25
Percentage of income from Appliances	50	45	90	95	85	85

The current 10-year Treasury notes have a yield to maturity of 3% and the forecast for the S&P 500 market premium is 6.5%. The companys overall b is 1.0.

Re= rist free rate of return +beta*(martketreturen-risk free rate of returen