Question
After looking at the projections of the HomeNet project, you decide that they are not realistic. It is unlikely that sales will be constant over
After looking at the projections of the HomeNet project, you decide that they are not realistic. It is unlikely that sales will be constant over the four-year life of the project. Furthermore, other companies are likely to offer competing products, so the assumption that the sales price will remain constant is also likely to be optimistic. Finally, as production ramps up, you anticipate lower per-unit production costs resulting from economies of scale. Therefore, you decide to redo the projections under the following assumptions Sales of 50,000 units in year 1 increasing by 50,000 units per year over the life of the project, a year 1 sales price of $260/unit, decreasing by 10% annually, and a year 1 cost of $120/unit decreasing by 20% annually. In addition, new tax laws allow 100% bonus depreciation (all the depreciation expense occurs when the asset is put into use, in this case in Year 0). Each year 20% of sales come from customers who would have purchased an existing Cisco router for $100/unit and that this router costs $60/unit to manufacture. The existing router's price will decrease by 10% annually, and its cost will decrease by 20% annually as well. The used equipment that Cisco purchased for $7.5 in Year 0 is sold in Year 5 for a salvage value of $0.5 million. Other assumptions remain the same, including lost rental and 4% inflation in SG&A expenses. a. Keeping the other assumptions that underlie Table 8.3 the same, recalculate unlevered net income (that is, reproduce Table 8.3 under the new assumptions. Please note that cannibalization and lost rent must be included. b. Calculate HomeNets net working capital requirements under the new assumptions.
Where do you include salvage? Show calculation? Show salvage how to calculate and incorporate in free cash flow- where does it go?
c. Calculate HomeNets FCF under the new assumptions?
These are the assumptions for the original Table 8.3
Key Assumptions Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Revenue and Costs HomeNet Ave. Price/Unit $260 $260 $260 $260
HomeNet Cost/Unit ($110) ($110) ($110) ($110)
Cannibalization Rate 25% 25% 25% 25%
Old product Ave. Price/Unit $100 $100 $100 $100
Old Product Cost/Unit ($60) ($60) ($60) ($60)
Operating Expenses Marketing & Support ($2,800,000) ($2,800,000) ($2,800,000) ($2,800,000)
Lost Rent ($200,000) ($200,000) ($200,000) ($200,000)
Hardware R&D (expensed) ($5,000,000) Software R&D (expensed) ($10,000,000)
Lab Equipment (capitalized) ($7,500,000)
Other Assumptions Corporate tax rate 20% 20% 20% 20% 20% 20%
Receivables (% of sales) 15% 15% 15% 15% 15%
Payables (% of COGS) 15% 15% 15% 15% 15%
Cost of Capital 12%
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