Case

You have just been hired by Internal Business Machines Corporation (IBM) in their capital budgeting division. Your first assignment is to determine the free cash flows and NPV of a proposed new type of tablet computer similar in size to an iPad but with the operating power of a high-end desktop system. Please read the descriptions given in the case for all the details you will need for your analysis. Using that information, create a capital budgeting model in the same or similar way, as described in the chapter, using Excel. Your Analysis Should Clearly Answer the Following Questions: 1. (5 Points) Obtain IBMs financial statements. (If you really worked for IBM you would already have this data, but at least you will not get fired if your analysis is off target.) Download the annual income statements, balance sheets, and cash flow statements for the last four fiscal years from Yahoo! Finance (finance.yahoo.com). Enter IBMs ticker symbol and then go to financials. 2. (Total 30 Points) You are now ready to estimate the Free Cash Flow for the new product. Compute the Free Cash Flow for each year using Eq. 8.5: FreeCashFlow = (Revenues - Costs - Depreciation) * (1 - tc) + Depreciation - CapEx - NWC Set up the timeline and computation of free cash flow in separate, contiguous columns for each year of the project life. Be sure to make outflows negative and inflows positive.

a. (5 Points) Assume that the projects profitability will be similar to IBMs existing projects in the latest fiscal year and estimate (revenues - costs) each year by using the latest EBITDA/Sales profit margin. Calculate EBITDA as EBIT plus Depreciation expense from the cash flow statement

b. (5 points) Determine the annual depreciation by assuming that IBM depreciates these assets by the straightline method over a five-year life.

c. (3 Points) Determine IBMs tax rate by using the current U.S. federal corporate income tax rate.

d. (7 Points) Calculate the net working capital required each year by assuming that the level of NWC will be a constant percentage of the projects sales. Use IBMs NWC/Sales for the latest fiscal year to estimate the required percentage. (Use only accounts receivable, accounts payable, and inventory to measure working capital. Other components of current assets and liabilities are harder to interpret and not necessarily reflective of the projects required NWCfor example, IBMs cash holdings.)

e. (5 points) To determine the free cash flow, deduct the additional capital investment and the change in net working capital each year.

f. (3 points) Use Excel to determine the NPV of the project using 12% as cost of capital.

g. (2 Points) What is the IRR of the project?

Total 15 Points) Perform a sensitivity analysis by varying the project forecasts as follows:

1. (5 Points) Suppose first year sales will equal 2%4% of IBMs revenues.
2. (5 Points) Suppose the cost of capital is 10%15%.
3. (5 points) Suppose revenue growth is constant after the first year at a rate of 0%10%.

Please do the analysis using the Excel spreadsheet. Please submit the spreadsheet showing your analysis. In the spreadsheet, highlight the answers to the questions asked above. Based on your analysis, please also submit a justification (in one or two pagesnot more than two) for any assumptions you made. You will receive no credit if you give no justification or a very weak or inconsistent justification.