5 Webmasters.com has developed a powerful new server that would be used for corporations' Internet activities. It 6 would cost $10 million at Year 0 to buy the equipment necessary to manufacture the server. The project would 7 require net working capital at the beginning of each year in an amount equal to 10% of the year's projected sales; 8 for example, NWC, = 10%(Sales). The servers would sell for $24,000 per unit, and Webmasters believes that 9 variable costs would amount to $17,500 per unit. After Year 1, the sales price and variable costs will increase at the 10 inflation rate of 3%. The company's nonvariable costs would be $1 million at Year 1 and would increase with 11 inflation. 12 13 The server project would have a life of 4 years. If the project is undertaken, it must be continued for the entire 4 14 years. Also, the project's returns are expected to be highly correlated with returns on the firm's other assets. The 15 firm believes it could sell 1,000 units per year. 16 17 18 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 19 cost of capital is 10% for average-risk projects, defined as projects with a coefficient of variation of NPV between 20 0.8 and 1.2. Low-risk projects are evaluated with a WACC of 8%, and high-risk projects at 13%. 22 a. Develop a spreadsheet model, and use it to find the project's NPV, IRR, and payback. 23 24 Input Data (in thousands of dollars) 25 Equipment cost $10,000 Key Results: 26 Net operating working capital/Sales 10% NPV = 27 First year sales (in units) 1,000 IRR 28 Sales price per unit $24.00 Payback = 29 Variable cost per unit (excl. depr.) $17.50 30 Nonvariable costs (excl. depr.). $1,000 31 Market value of equipment at Year 4 $500 32 Tax rate 40% 33 WACC 10% 34 Inflation in prices and costs 3.0% 35 Estimated salvage value at year 4 $500 36 37 Intermediate Calculations 0 2 38 Units sold 39 Sales price per unit (excl. depr.) 40 Variable costs per unit (excl. depr.) 41 Nonvariable costs (excl. depr.) 42 Sales revenue 43 Required level of net operating working capital 44 Basis for depreciation $10,000 45 Annual equipment depr. rate 20.00% 32.00% 46 Annual depreciation expense 47 Ending Bk Val: Cost - Accum Dep'rn $10,000 48 Salvage value 49 Profit (or loss) on salvage 50 Tax on profit (or loss) 51 Net cash flow due to salvage 1 3 4 19.20% 11.52% $500 5 Webmasters.com has developed a powerful new server that would be used for corporations' Internet activities. It 6 would cost $10 million at Year 0 to buy the equipment necessary to manufacture the server. The project would 7 require net working capital at the beginning of each year in an amount equal to 10% of the year's projected sales; 8 for example, NWC, = 10%(Sales). The servers would sell for $24,000 per unit, and Webmasters believes that 9 variable costs would amount to $17,500 per unit. After Year 1, the sales price and variable costs will increase at the 10 inflation rate of 3%. The company's nonvariable costs would be $1 million at Year 1 and would increase with 11 inflation. 12 13 The server project would have a life of 4 years. If the project is undertaken, it must be continued for the entire 4 14 years. Also, the project's returns are expected to be highly correlated with returns on the firm's other assets. The 15 firm believes it could sell 1,000 units per year. 16 17 18 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 19 cost of capital is 10% for average-risk projects, defined as projects with a coefficient of variation of NPV between 20 0.8 and 1.2. Low-risk projects are evaluated with a WACC of 8%, and high-risk projects at 13%. 22 a. Develop a spreadsheet model, and use it to find the project's NPV, IRR, and payback. 23 24 Input Data (in thousands of dollars) 25 Equipment cost $10,000 Key Results: 26 Net operating working capital/Sales 10% NPV = 27 First year sales (in units) 1,000 IRR 28 Sales price per unit $24.00 Payback = 29 Variable cost per unit (excl. depr.) $17.50 30 Nonvariable costs (excl. depr.). $1,000 31 Market value of equipment at Year 4 $500 32 Tax rate 40% 33 WACC 10% 34 Inflation in prices and costs 3.0% 35 Estimated salvage value at year 4 $500 36 37 Intermediate Calculations 0 2 38 Units sold 39 Sales price per unit (excl. depr.) 40 Variable costs per unit (excl. depr.) 41 Nonvariable costs (excl. depr.) 42 Sales revenue 43 Required level of net operating working capital 44 Basis for depreciation $10,000 45 Annual equipment depr. rate 20.00% 32.00% 46 Annual depreciation expense 47 Ending Bk Val: Cost - Accum Dep'rn $10,000 48 Salvage value 49 Profit (or loss) on salvage 50 Tax on profit (or loss) 51 Net cash flow due to salvage 1 3 4 19.20% 11.52% $500