company $($implying the project will have the same ratio of EBITDA to sales and working capital"I.

to sales$)$ and that depreciation is straight$-$line $($over $5$ years$)$ for capital budgeting purposes. Since

your boss hasn't been much help $($welcome to the "real world"!$),$ here are some tips to guide your

analysis:

Obtain IBM's financial statements. $($If you really worked for IBM you would already have this data,

but at least you won't get fired if your analysis is off target.$)$ Download the annual income state$-$

ments, balance sheets, and cash flow statements for the last four fiscal years from Yahoo! Finance

$($

finance.yahoo.com$).$ Enter IBM's ticker symbol and then go to "financials."

You are now ready to estimate the Free Cash Flow for the new product. Compute the Free Cash

Flow for each year using Eq$.8\mathrm{.}5$:

Free Cash Flow $=$obrace$(($ Revenues $-$ Costs $-$ Depreciation $)(1-{}_c){)}^{\text{U}\text{n}\text{l}\text{e}\text{v}\text{e}\text{r}\text{e}\text{d}\text{N}\text{e}\text{t}\text{I}\text{n}\text{c}\text{o}\text{m}\text{e}}$

$+$ 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$.$ Assume that the project's profitability will be similar to IBM's existing projects in the latest

fiscal year and estimate $($revenues $-$ costs$)$ each year by using the latest EBITDA$/$Sales

profit margin. Currently, Yahoo reports EBITDA at the bottom of the income statement.

Verify this number by adding Income Before Tax, Interest Expense, and Depreciation &

amortization $($from the cash flow statement$).$ If the two numbers are inconsistent, use the

latter method to calculate EBITDA.

b$.$ Determine the annual depreciation by assuming IBM depreciates these assets by the straight$-$

line method over a five$-$year life.

c$.$ Determine IBM's tax rate by using the current U$.$S$.$ federal corporate income tax rate.

d$.$ Calculate the net working capital required each year by assuming that the level of NWC will

be a constant percentage of the project's sales. Use IBM's 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 project's required NWC$-$for

example, IBM's cash holdings.$)$

e$.$ To determine the free cash flow, deduct the additional capital investment and the change in

net working capital each year.

Use Excel to determine the NPV of the project with a $12\%$ cost of capital. Also calculate the IRR

of the project using Excel's IRR function.

Perform a sensitivity analysis by varying the project forecasts as follows:

a$.$ Suppose first year sales will equal $2\%-4\%$ of IBM's revenues.

b$.$ Suppose the cost of capital is $10\%-15\%.$

c$.$ Suppose revenue growth is constant after the first year at a rate of $0\%-10\%.$

Note: Updates to this data case may be found at

www$.$berkdemarzo.com.