Canyon Buff Corp. has developed a new construction chemical that greatly improves the durability and weatherability of cement-based materials. After spending $500,000 on the research of the potential market for the new chemical, Canyon Buff is considering a project that requires an initial investment of $9,000,000 in manufacturing equipment.

The equipment must be purchased before the chemical production can begin. For tax purposes, the equipment is subject to a 5-year straight-line depreciation schedule, with a projected zero salvage value. For simplicity, however, we will continue to assume that the asset can actually be used out into the indefinite future (i.e., the actual useful life is effectively infinite).

Canyon Buff anticipates that the sales will be $30,000,000 in the first year (Year 1). They expect that sales will initially grow at an annual rate of 6% until the end of sixth year. After that, the sales will grow at the estimated 2% annual rate of inflation in perpetuity.

The cost of goods sold is estimated to be 72% of sales.

The accounting department also estimates that at introduction in Year 0, the new product's required initial net working capital will be $6,000,000. In future years accounts receivable are expected to be 15% of the next year sales, inventory is expected to be 20% of the next years cost of goods sold and accounts payable are expected to be 15% of the next years cost of goods sold.

The selling, general and administrative expense is estimated to be $6,000,000 per year, but $1 million of this amount is the overhead expense that will be incurred even if the project is not accepted.

The market research to support the product was completed last month at a cost of $500,000 to be paid by the end of next year.

The annual interest expense tied to the project is $1,000,000

Canyon Buff has a cost of capital of 20% and faces a marginal tax rate of 30% and an average tax rate is 20%.

QUESTION:

Perform a sensitivity analysis by varying the four parameters as follows:

Parameter / Initial Assumption / Worst Case / Best Case Sales in Year 1 NPV / $30,000 / $27,000 / $33,000 Sales Growth through Year 6 NPV / 6% / 0% / 10% Cost of Goods Sold (% of Sales) NPV / 72% / 77% / 67% Cost of Capital NPV / 20% / 23% / 17%

For example, vary the parameter Sales in Year 1 from the worst case $27,000 to the best case $33,000, holding all the other parameters fixed (at the level of initial assumptions). Then fill in the highlighted blank boxes for NPV in Excel (the sheet Sensitivity Analysis)

Do the same thing for the other three parameters.

Suppose you are the financial manager, if you are asked to use limited resources to refine the assumption on ONLY ONE of the above four parameters, which one should you choose and why? Write your answer in Excel.