Question
IBM is considering a new expansion project and the finance staff has received information summarized below. The project requires IBM to purchase $500,000 of equipment
IBM is considering a new expansion project and the finance staff has received information summarized below.
The project requires IBM to purchase $500,000 of equipment in 2013 (t=0).
Account Receivables will increase by $200,000 and accounts payable will rise by $50,000.
The project will last for four years. The company forecasts that they will sell 2,685,000 units in 2014, 2,600,000 units in 2015, 2,525,000 units in 2016, and 2,450,000 units in 2017. Each unit will sell for $2.5.
The fixed cost of producing the product is $1 million each year.
The variable cost of producing each unit will rise from $1.01, 1.02, 1.03 and $1.04 from 2013 to 2017 respectively.
The equipment will be depreciated under the MACRS system using the applicable rates of 33%, 45%, 15%, and 7% respectively
When the project is completed in 2017 (t=4), the company expects that it will be able to salvage the equipment for $100,000, and it expects that it will fully recover the NWC.
The estimated tax rate is 35%.
Based on the perceived risk, the projects WACC is estimated to be 12%.
Calculate the Operating Cash Flows (OCF) for each year.
Use table on Canvas with 5 columns
List accounts in this column. | Year 1 | 2 | 3 | 4 |
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9. Create the projected Free Cash Flow Schedule for the project:
Create a table on Canvas with 5 columns
Projected Free Cash Flow Schedule
Year 0 Year 1 Year 2 Year 3 Year 4
OCF OCF OCF OCF
- Equipment cost + After-tax Salvage Value
- NWC + Total NWC
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Total Free Cash Flows
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10. Calculate the Net Present Value (NPV) using cash flow keys. List the steps.
11. Should the project be accepted or rejected based on the NPV? Explain
12. Calculate the IRR using cash flow keys. List the steps.
11. Should the project be accepted or rejected based on the IRR? Explain
12. In your own words, present the project to the owners using the Free Cash Flow figures.
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