Capital Budgeting FuncoLand has developed a powerful new server that would be used for corporations' Internet activities. It would cost $10,000,000 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 $22,000 per unit, and Web- masters believes that variable costs would amount to $17,000 per unit. After Year 1, the sales price and variable costs will increase at the inflation rate of 2%. The company's nonvariable costs would be $1,000,000 at Year 1 and would increase each year by the inflation rate. 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 (see page 543). The estimated market value of the equipment at the end of the project's 4-year life is $500,000. FuncoLand's federal-plus-state tax rate is 42%. Its cost of capital is 10%.

Part 3: Cash Flow Estimation

A) Calculate the net operating working capital for each year.

B) Calculate the net cash flow due to salvage.

(C) Calculate net cash flows for each year.

Part 2: Capital Budgeting Analysis

D) Calculate the NPV, IRR, MIRR, Payback and Discounted Payback.

Input Data

Equipmentcost $10,000,000

Net operating working capital/Sales 10%

First year sales (in units) 1000

Sales price per unit first year $22,000

Variable cost per unit first year (excl. depr.) $17,000

Nonvariable costs first year (excl. depr.) $1,000,000

Market value of equipment at Year 4 $500,000

Tax rate 42%

WACC 10%

Inflation in prices and costs 2%

Part 1: Cash Flow Estimation

A) NOWC

Year 0 1 2 3 4

Units sold

Sales price per unit (excl. depr.)

Variable costs per unit (excl. depr.)

Nonvariable costs (excl. depr.)

Variable costs

Sales revenue

Net Operating Working Capital

B) Salvage

Year 0 1 2 3 4

Basis for depreciation

Annual equipment depreciation rate

Annual depreciation expense

Ending Book Value: Depr. Expense - Accum. Depr.

Salvage value

Profit (or loss) on salvage

Tax on profit (or loss)

Net cash flow due to salvage

C) Cash Flows

Years 0 1 2 3 4

Sales revenue (per 1,000 units)

Variable costs (per 1,000 units)

Nonvariable operating costs

Depreciation (equipment)

Oper. income before taxes (EBIT)

Taxes on operating income (42%)

Net operating profit after taxes

Add back depreciation

Equipment purchases

Cash flow due to change in NOWC

Net cash flow due to salvage

Net Cash Flow

Part 2: Capital Budgeting Analysis

F) Capital Budgeting Criterion

Net Present Value (at 10%) =

IRR =

MIRR =

Payback =

Discounted Payback =

Data for Payback

Years 0 1 2 3 4

Net cash flow

Cumulative CF

Data for Discounted Payback

Years 0 1 2 3 4

Net cash flow

Discounted CF

Cumulative CF