Amadeus Corporation is considering the issue of a new product to be added to its product mix. They hired you, a recent business graduate from MacEwan, for conducting the analysis. The production line would be set up in an unused space at the company’s main plant. The plant space could be leased out to another firm at $25,000 per year. They have to buy new machinery. The approximate cost of the machine would be $200,000, with another $10,000 in shipping and handling charges. It would also cost an additional $30,000 to install the equipment. The machinery has an economic life of 5 years and would be in Class 8 with a CCA rate of 20%. The machinery is expected to have a salvage value of $25,000 after 5 years of use.

The new product line would generate incremental sales of 1,450 units per year for 5 years and they are expected to grow 10% per year. The cost per unit is estimated in $75 per unit in the first year. Each unit can be sold for $200 in the first year. The sales price and cost are both expected to increase by 2.5% per year due to inflation. The fixed costs are estimated to be $100,000 at the end of 1^st year and would increase with inflation. To handle the new product line, the firm’s net operating working capital would be an amount equal to 15% of sales revenues. The firm tax rate is 35%, and its overall weighted average cost of capital (WACC) is 8%. The project is considered by the financial department to be as risky as the company.

Requirements:

Using an Excel spreadsheet:

• Find the NPV, IRR, and discounted payback period (PBP) of the project by using the pro forma financial statement method to determine cash flows.
• Enter the input variables in cells of their own at the top of the spreadsheet (so it is easier to do sensitivity analysis calculations).
• Set up the necessary equations by referencing to the input variable cells. The spreadsheet must be formula driven; do not put any numbers in equations, only cell references.
• Use Excel’s built-in functions wherever possible (e.g. NPV and IRR functions).

2. Breakeven analysis (cash B/E point only)

Set up a formula in Excel (this formula is not built-in) to calculate the cash breakeven point for the base case.

Hint:

The cash breakeven point shows a level of sales that the operating cash flow (OCF) would be zero. Cash B/E point can be calculated:

Q = FC / (P-V)

Q = Level of sales

FC = Fixed costs

P = Price level

V = Variable cost per unit

3. Sensitivity analysis

Consider the following assumptions for the company and for each case individually calculate the NPV and the IRR and include these analyses in your final recommendation.

Perform sensitivity analysis on the unit sales, variable costs, and the cost of capital for the project. Assume that each of these variables can vary from its base-case value by ±20%. Summarize the results in a table (NPVs and IRRs for each sensitivity analysis).

4. Scenario Analysis

Assume that you are confident of your estimates of all variables that affect the project’s cash flows except unit sales and sales price. If product acceptance is poor, unit sales will be only 900 units a year and the unit price will be only $160; a strong demand will produce sales of 1,600 units and a unit price of $240. The marketing department told you that there is a 25% chance of poor acceptance and 25% chance of strong acceptance and a 50% chance of average acceptance (the base case).

(a) What are the worst-case NPV and the best-case NPV?

(b) What are the expected NPV and risk involved given the mentioned probabilities?