Devon Inc. has developed a powerful efficient snow blower that is significantly less polluting than existing snow blowers currently on the market. The company spent $2,500,000 developing this product and the marketing department spent another $350,000 to assess the market demand. It would cost $25 million at Year 0 to buy the equipment necessary to manufacture the efficient snow blower. The project would require net working capital at the beginning of each year equal to 20% of sales (NOWC0 = 20%(Sales1), NOWC1 = 20%(Sales2), etc.). The efficient snow blowers would sell for $3,500 per unit, and the company believes that variable costs would amount to $990 per unit. The company expects that the sales price and variable costs would increase at the inflation rate of 4% after year 1. The companys non-variable costs would be $800,000 in Year 1 and are expected to increase with inflation. The efficient snow blower 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 is expected to be of average risk. The firm believes it could sell 3,500 units per year. The equipment would be depreciated using a CCA rate of 30%. The estimated market value of the equipment at the end of the projects 4-year life is its undepreciated capital cost (i.e. book value) at the end of year 4. The company has other assets in this asset class. Toefield Inc.s federal-plus-provincial tax rate is 30%. Its cost of capital is 7% for average risk projects. Low-risk projects are evaluated with a WACC of 6%, and high-risk projects at 10%. Assume that the half-year rule applies to the CCA.

J A B D E F G H 60 61 Working Capital: 62 Required level of net operating working capital 63 Required investment in NOWC 64 65 Terminal Year Cash Flows: 66 Net salvage value 67 68 Net Cash Flow (Time line of cash flows) 69 70 Part 4. Key Output: Appraisal of the Proposed Project 71 72 Net Present Value (at 9%) 73 IRR 74 MIRR 75 76 Payback (See calculation below) 77 78 Data for Payback Years 79 Net cash flow 80 Cumulative CF 81 Part of year required for payback: 0.00 0.00 0.00 0.00 82 83 84 85 b. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and number of 86 units sold. Set these variables' values at 10% and 25% above and below their base case values. Include a graph in your analysis. 87 88 Evaluating Risk: Sensitivity Analysis 89 90 I. Sensitivity of NPV to Changes in Inputs. Here we use an Excel "Data Table" to find NPV for different unit sales, variable costs, WACC, and 91 sales prices, holding other thing constant. 92 93 % Deviation 1st YEAR UNIT SALES Deviation WACC 94 from Units NPV from NPV 95 Base Case Sold $0 Base Case WACC 0 96 -25% $0 -25% 0.00% SO 97 -10% $0 -10% 0.00% $0 98 0% $0 0% SO 99 10% $0 10% 0.00% $0 100 25% $0 25% 0.00% $0 10 126 fx 6% A B D E F G H J 43 Investment Outlays at Time Zero: 44 Equipment 45 46 Operating Cash Flows over the Project's Life: 47 Units sold 48 Sales price 49 Variable costs 50 51 Sales revenue 52 Variable costs 53 Non-variable operating costs 54 Depreciation (equipment) 55 Oper. income before taxes (EBIT) 56 Taxes on operating income 57 Net Operating Profit After Taxes (NOPAT) 58 Add back depreciation 59 Operating cash flow 60 61 Working Capital: 62 Required level of net operating working capital 63 Required investment in NOWC 64 65 Terminal Year Cash Flows: 66 Net salvage value 67 68 Net Cash Flow (Time line of cash flows) 69 70 Part 4. Key Output: Appraisal of the Proposed Project 71 72 Net Present Value (at 9%) 73 IRR 74 MIRR 75 76 Payback (See calculation below) 77 78 Data for Payback Years 79 Net cash flow 80 Cumulative CF 81 Part of year required for payback: 82 83 0.00 0.00 0.00 0.00 Solution + 59 90 I. Sensitivity of NPV to Changes in Inputs. Here we use an Excel "Data Table" to find NPV for different unit sales, variable costs, WACC, and 91 sales prices, holding other thing constant. 32 93 % Deviation 1st YEAR UNIT SALES % Deviation WACC 34 from Units NPV from NPV 25 Base Case Sold $0 Base Case WACC 0 96 -25% $0 -25% 0.00% $0 37 -10% $0 -10% 0.00% $0 38 0% SO 0% SO 39 10% $0 10% 0.00% $0 00 25% SO 25% 0.00% $0 01 02 % Deviation VARIABLE COSTS % Deviation SALES PRICE 03 from Variable NPV from Sales NPV 04 Base Case Costs $0 Base Case Price $0 05 -25% 0.00 SO -25% 0.00 $0 06 -10% 0.00 $0 -10% 0.00 SO 07 0% SO 0% $0 08 10% 0.00 SO 10% 0.00 $0 09 25% 0.00 $0 25% 0.00 $0 10 11 % Deviation NON-VARIABLE COSTS 12 from Fixed NPV Note about data tables. The data in the column input should NOT be input using 13 Base Case Costs so a cell reference to the column input cell. For example the base case number of 14 -25% $0 units sold in cell B100 should be the number 1000; you should NOT have the 15 -10% $0 formula =D29 in that cell. This is because you'll use D29 as the column input cell 16 0% $0 in the data table and if Excel tries to iteratively replace cell D29 with the formula 17 10% SO =D29 rather than a series of numbers, Excel will calculate the wrong answer. 18 25% SO Unfortunately, Excel won't tell you that there is a problem, so you'll just get the 19 wrong values for the data table! 20 21 22 Sensitivity Analysis 23 24 25 $11,000 26 27 $9,000 28 $7,000 --Sales price 29 $5,000 ---VC Solution + 2n Ready 59 90 I. Sensitivity of NPV to Changes in Inputs. Here we use an Excel "Data Table" to find NPV for different unit sales, variable costs, WACC, and 91 sales prices, holding other thing constant. 32 93 % Deviation 1st YEAR UNIT SALES % Deviation WACC 34 from Units NPV from NPV 25 Base Case Sold $0 Base Case WACC 0 96 -25% $0 -25% 0.00% $0 37 -10% $0 -10% 0.00% $0 38 0% SO 0% SO 39 10% $0 10% 0.00% $0 00 25% SO 25% 0.00% $0 01 02 % Deviation VARIABLE COSTS % Deviation SALES PRICE 03 from Variable NPV from Sales NPV 04 Base Case Costs $0 Base Case Price $0 05 -25% 0.00 SO -25% 0.00 $0 06 -10% 0.00 $0 -10% 0.00 SO 07 0% SO 0% $0 08 10% 0.00 SO 10% 0.00 $0 09 25% 0.00 $0 25% 0.00 $0 10 11 % Deviation NON-VARIABLE COSTS 12 from Fixed NPV Note about data tables. The data in the column input should NOT be input using 13 Base Case Costs so a cell reference to the column input cell. For example the base case number of 14 -25% $0 units sold in cell B100 should be the number 1000; you should NOT have the 15 -10% $0 formula =D29 in that cell. This is because you'll use D29 as the column input cell 16 0% $0 in the data table and if Excel tries to iteratively replace cell D29 with the formula 17 10% SO =D29 rather than a series of numbers, Excel will calculate the wrong answer. 18 25% SO Unfortunately, Excel won't tell you that there is a problem, so you'll just get the 19 wrong values for the data table! 20 21 22 Sensitivity Analysis 23 24 25 $11,000 26 27 $9,000 28 $7,000 --Sales price 29 $5,000 ---VC Solution + 2n Ready J A B D E F G H 60 61 Working Capital: 62 Required level of net operating working capital 63 Required investment in NOWC 64 65 Terminal Year Cash Flows: 66 Net salvage value 67 68 Net Cash Flow (Time line of cash flows) 69 70 Part 4. Key Output: Appraisal of the Proposed Project 71 72 Net Present Value (at 9%) 73 IRR 74 MIRR 75 76 Payback (See calculation below) 77 78 Data for Payback Years 79 Net cash flow 80 Cumulative CF 81 Part of year required for payback: 0.00 0.00 0.00 0.00 82 83 84 85 b. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and number of 86 units sold. Set these variables' values at 10% and 25% above and below their base case values. Include a graph in your analysis. 87 88 Evaluating Risk: Sensitivity Analysis 89 90 I. Sensitivity of NPV to Changes in Inputs. Here we use an Excel "Data Table" to find NPV for different unit sales, variable costs, WACC, and 91 sales prices, holding other thing constant. 92 93 % Deviation 1st YEAR UNIT SALES Deviation WACC 94 from Units NPV from NPV 95 Base Case Sold $0 Base Case WACC 0 96 -25% $0 -25% 0.00% SO 97 -10% $0 -10% 0.00% $0 98 0% $0 0% SO 99 10% $0 10% 0.00% $0 100 25% $0 25% 0.00% $0 10 126 fx 6% A B D E F G H J 43 Investment Outlays at Time Zero: 44 Equipment 45 46 Operating Cash Flows over the Project's Life: 47 Units sold 48 Sales price 49 Variable costs 50 51 Sales revenue 52 Variable costs 53 Non-variable operating costs 54 Depreciation (equipment) 55 Oper. income before taxes (EBIT) 56 Taxes on operating income 57 Net Operating Profit After Taxes (NOPAT) 58 Add back depreciation 59 Operating cash flow 60 61 Working Capital: 62 Required level of net operating working capital 63 Required investment in NOWC 64 65 Terminal Year Cash Flows: 66 Net salvage value 67 68 Net Cash Flow (Time line of cash flows) 69 70 Part 4. Key Output: Appraisal of the Proposed Project 71 72 Net Present Value (at 9%) 73 IRR 74 MIRR 75 76 Payback (See calculation below) 77 78 Data for Payback Years 79 Net cash flow 80 Cumulative CF 81 Part of year required for payback: 82 83 0.00 0.00 0.00 0.00 Solution + 59 90 I. Sensitivity of NPV to Changes in Inputs. Here we use an Excel "Data Table" to find NPV for different unit sales, variable costs, WACC, and 91 sales prices, holding other thing constant. 32 93 % Deviation 1st YEAR UNIT SALES % Deviation WACC 34 from Units NPV from NPV 25 Base Case Sold $0 Base Case WACC 0 96 -25% $0 -25% 0.00% $0 37 -10% $0 -10% 0.00% $0 38 0% SO 0% SO 39 10% $0 10% 0.00% $0 00 25% SO 25% 0.00% $0 01 02 % Deviation VARIABLE COSTS % Deviation SALES PRICE 03 from Variable NPV from Sales NPV 04 Base Case Costs $0 Base Case Price $0 05 -25% 0.00 SO -25% 0.00 $0 06 -10% 0.00 $0 -10% 0.00 SO 07 0% SO 0% $0 08 10% 0.00 SO 10% 0.00 $0 09 25% 0.00 $0 25% 0.00 $0 10 11 % Deviation NON-VARIABLE COSTS 12 from Fixed NPV Note about data tables. The data in the column input should NOT be input using 13 Base Case Costs so a cell reference to the column input cell. For example the base case number of 14 -25% $0 units sold in cell B100 should be the number 1000; you should NOT have the 15 -10% $0 formula =D29 in that cell. This is because you'll use D29 as the column input cell 16 0% $0 in the data table and if Excel tries to iteratively replace cell D29 with the formula 17 10% SO =D29 rather than a series of numbers, Excel will calculate the wrong answer. 18 25% SO Unfortunately, Excel won't tell you that there is a problem, so you'll just get the 19 wrong values for the data table! 20 21 22 Sensitivity Analysis 23 24 25 $11,000 26 27 $9,000 28 $7,000 --Sales price 29 $5,000 ---VC Solution + 2n Ready 59 90 I. Sensitivity of NPV to Changes in Inputs. Here we use an Excel "Data Table" to find NPV for different unit sales, variable costs, WACC, and 91 sales prices, holding other thing constant. 32 93 % Deviation 1st YEAR UNIT SALES % Deviation WACC 34 from Units NPV from NPV 25 Base Case Sold $0 Base Case WACC 0 96 -25% $0 -25% 0.00% $0 37 -10% $0 -10% 0.00% $0 38 0% SO 0% SO 39 10% $0 10% 0.00% $0 00 25% SO 25% 0.00% $0 01 02 % Deviation VARIABLE COSTS % Deviation SALES PRICE 03 from Variable NPV from Sales NPV 04 Base Case Costs $0 Base Case Price $0 05 -25% 0.00 SO -25% 0.00 $0 06 -10% 0.00 $0 -10% 0.00 SO 07 0% SO 0% $0 08 10% 0.00 SO 10% 0.00 $0 09 25% 0.00 $0 25% 0.00 $0 10 11 % Deviation NON-VARIABLE COSTS 12 from Fixed NPV Note about data tables. The data in the column input should NOT be input using 13 Base Case Costs so a cell reference to the column input cell. For example the base case number of 14 -25% $0 units sold in cell B100 should be the number 1000; you should NOT have the 15 -10% $0 formula =D29 in that cell. This is because you'll use D29 as the column input cell 16 0% $0 in the data table and if Excel tries to iteratively replace cell D29 with the formula 17 10% SO =D29 rather than a series of numbers, Excel will calculate the wrong answer. 18 25% SO Unfortunately, Excel won't tell you that there is a problem, so you'll just get the 19 wrong values for the data table! 20 21 22 Sensitivity Analysis 23 24 25 $11,000 26 27 $9,000 28 $7,000 --Sales price 29 $5,000 ---VC Solution + 2n Ready