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2 Chapter: 3 Problem 11 18 Estimating Cash Flows and Analyzing Risk Webmasters.com has developed a powerful new server that would be used for corporations' Internet activities. It would cost $10 million 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, NWC.-10%( Sales,). The servers would sell for $24,000 per unit, and Webmasters believes that variable costs would amount to $17,500 per unit. After Year 1, the sales price and variable costs will increase at the inflation rate of 3%. The company's nonvariable costs would be $1 million at Year 1 and would increase with inflation 13The server project would have a life of 4 years. If the project is undertaken, it must be continued for the entire 4 14 years. Also, the project's returns are expected to be highly correlated with returns on the firm's other assets. The 15 firm believes it could sell 1,000 units per year. The equipment would be depreciated over a 5-year period, using MACRS rates. The estimated market value of 18 the equipment at the end ofthe project's 4-year life is $500,000, webmasters, federal-plus-state tax rate is 40%. Its 19 cost of capital is 10% for average-risk projects, defined as projects with a coefficient of variation of NPV between 0.8 land 1.2. Low-risk projects are evaluated with a WACC of 8%, and high-risk projects at 13%. 21 22 a. Develop a spreadsheet model, and use it to find the project's NPV, IRR, and payback 23 24 Input Data (in thousands of dollars 25 Equipment cost 26 |Net operating working capital/Sales 27 First year sales (in units 28 Sales price per unit 29 Variable cost per unit (excl. depr 30 Nonvariable costs (excl. depr 31 Market value of equipment at Year 4 32 Tax rate 33 WACC $10,000 Key Results: 10 1,000 IRRE Payback $17.50 $1,000 $500 10% Page 1