Homework

Parker Products manufactures a variety of household products. The company is considering introducing a new detergent. The companys CFO has collected the following information about the proposed product.

The project has an anticipated economic life of 4 years.

The company will have to purchase a new machine to produce the detergent. The machine has an up-front cost (t = 0) of $2 million. The machine will be depreciated on a straight-line basis to a value of $600,000 over 4 years. The company anticipates that after four years, its salvage value will equal $250,000.

If the company goes ahead with the proposed product, it will have an effect on the companys net working capital. At the outset, t = 0, inventory will increase by $140,000 and accounts payable will increase by $40,000. At t = 4, the net working capital will be recovered after the project is completed.

The detergent is expected to generate sales revenue of $1 million the first year (t = 1), $2 million the second year (t = 2), $2 million the third year (t = 3), and $1 million the final year (t = 4). Each year the variable operating costs (not including depreciation) are expected to equal 40 percent of sales revenue. The project would increase the companys fixed costs by $120,000 per year.

The new detergent is expected to reduce the after-tax cash flows of the companys existing products *+by $100,000 a year (t = 1, 2, 3, and 4).

The companys overall WACC is 10 percent. However, the proposed project is riskier than the average project for Parker; the projects WACC is estimated to be 12 percent.

The companys tax rate is 40 percent.

Develop a spreadsheet model and use it to find the projects NPV and IRR.

GOAL SEEK

Find the amount of annual fixed costs that will result in zero NPV for the project. Print the parameter area.

c. ONE-WAY DATA TABLE

Now conduct a sensitivity analysis to determine the sensitivity of NPV and IRR to changes in the variable operating costs. What will be the NPV and IRR, if variable operating costs varies from 25% of sales revenue to 45% of sales revenue in increments of 5%. Format the IRR cells to 2 decimal points (e.g. 6.35%). Print the data table with the formula row/column hidden.

d. TWO-WAY DATA TABLE

What will be the NPV, if salvage value varies from $200,000 to $280,000 in increments of $10,000 and fixed costs varies from $100,000 to $160,000 in increments of $10,000. Print the data table with the formula cell hidden

e. SCENARIO SUMMARY

Now conduct a scenario analysis. Use the following scenarios and prepare a scenario report. Print the scenario summary after hiding the current values column.

	Worst	Base	Best
Machine Cost	2,000,000	2,000,000	2,000,000
Life	4	4	4
BV at the end of project	600,000	600,000	600,000
Salvage value	200,000	250,000	300,000
Sales Year 1	800,000	1,000,000	1,200,000
Sales Year 2	1,600,000	2,000,000	2,400,000
Sales Year 3	1,600,000	2,000,000	2,400,000
Sales Year 4	800,000	1,000,000	1,200,000
Variable Opr. Costs/Sales	40%	35%	30%
Fixed Costs	140,000	120,000	100,000
Reduction of ATCF	100,000	100,000	100,000
Change in Inventory	140,000	140,000	140,000
Change in A/P	40,000	40,000	40,000
Tax Rate	30%	30%	30%
Discount Rate	12%	12%	12%

Homework

Parker Products manufactures a variety of household products. The company is considering introducing a new detergent. The companys CFO has collected the following information about the proposed product.

The project has an anticipated economic life of 4 years.

The company will have to purchase a new machine to produce the detergent. The machine has an up-front cost (t = 0) of $2 million. The machine will be depreciated on a straight-line basis to a value of $600,000 over 4 years. The company anticipates that after four years, its salvage value will equal $250,000.

If the company goes ahead with the proposed product, it will have an effect on the companys net working capital. At the outset, t = 0, inventory will increase by $140,000 and accounts payable will increase by $40,000. At t = 4, the net working capital will be recovered after the project is completed.

The detergent is expected to generate sales revenue of $1 million the first year (t = 1), $2 million the second year (t = 2), $2 million the third year (t = 3), and $1 million the final year (t = 4). Each year the variable operating costs (not including depreciation) are expected to equal 40 percent of sales revenue. The project would increase the companys fixed costs by $120,000 per year.

The new detergent is expected to reduce the after-tax cash flows of the companys existing products *+by $100,000 a year (t = 1, 2, 3, and 4).

The companys overall WACC is 10 percent. However, the proposed project is riskier than the average project for Parker; the projects WACC is estimated to be 12 percent.

The companys tax rate is 40 percent.

Develop a spreadsheet model and use it to find the projects NPV and IRR.

GOAL SEEK

Find the amount of annual fixed costs that will result in zero NPV for the project. Print the parameter area.

c. ONE-WAY DATA TABLE

Now conduct a sensitivity analysis to determine the sensitivity of NPV and IRR to changes in the variable operating costs. What will be the NPV and IRR, if variable operating costs varies from 25% of sales revenue to 45% of sales revenue in increments of 5%. Format the IRR cells to 2 decimal points (e.g. 6.35%). Print the data table with the formula row/column hidden.

d. TWO-WAY DATA TABLE

What will be the NPV, if salvage value varies from $200,000 to $280,000 in increments of $10,000 and fixed costs varies from $100,000 to $160,000 in increments of $10,000. Print the data table with the formula cell hidden

e. SCENARIO SUMMARY

Now conduct a scenario analysis. Use the following scenarios and prepare a scenario report. Print the scenario summary after hiding the current values column.

	Worst	Base	Best
Machine Cost	2,000,000	2,000,000	2,000,000
Life	4	4	4
BV at the end of project	600,000	600,000	600,000
Salvage value	200,000	250,000	300,000
Sales Year 1	800,000	1,000,000	1,200,000
Sales Year 2	1,600,000	2,000,000	2,400,000
Sales Year 3	1,600,000	2,000,000	2,400,000
Sales Year 4	800,000	1,000,000	1,200,000
Variable Opr. Costs/Sales	40%	35%	30%
Fixed Costs	140,000	120,000	100,000
Reduction of ATCF	100,000	100,000	100,000
Change in Inventory	140,000	140,000	140,000
Change in A/P	40,000	40,000	40,000
Tax Rate	30%	30%	30%
Discount Rate	12%	12%	12%