MacroHard considers selling a Virtual Reality device set HoloGlobe. The management anticipates that new system will have the first year revenues of $500,000 K with subsequent annual revenue growth of 20%. Operating costs are 70% of revenues.

The project requires $600 Mil investment in equipment, which will have a five year anticipated life and will be depreciated using five year MACRS depreciation method toward a zero book value (five year MACRS official depreciation rates are given below - it does require 6 years, this is not a typo!). However, the company will be able to sell the equipment on the after-market at the end of year 5 for 20% of its original cost. The company requires an 12% rate of return from its investment and faces a 35% tax rate (overall the company is profitable). In addition to capital investment, the project requires an outlay of net working capital equal to 20% of revenues in the coming year. I.e., at time 0 (beginning of year 1) net working capital requirement is $100,000 K and will grow in subsequent years. All NWC will be recovered after the project's end.

a) Calculate the NPV and IRR for the project. Should the company undertake the project? (see chapter 2 for details)

b) The marketing and operations department disagree with current projections for operating costs, first year revenues and revenue growth . Considering one factor at a time, at what level of operating costs, initial revenues, and revenues growth (decline) the project will break-even (NPV=0)? (see chapter 3 for details)

c) Looking at percentage difference between the predicted level and critical (break-even) level of each of the three factors, which of them is the most critical?

Given				MACRS 5 Year Depreciation		Asset Book Value
Investment cost (today)	$ (600,000,000)			Year 1	20.00%
Project Life	5	years		Year 2	32.00%
Net Working Capital	20.00%	of revenues		Year 3	19.20%
Year 1 revenues	$ 500,000,000			Year 4	11.52%
Operating costs	70.00%	of revenues		Year 5	11.52%
After-market (salvage) value	20%	of initial investment		Year 6	5.76%
Revenue annual growth	20.00%
Required rate of return	12.00%
Tax rate	35%
Solution
	Year
Cash flow estimation	0	1	2	3	4	5
Investment	$ (600,000,000)
Revenues		500,000,000	600,000,000	720,000,000	864,000,000	1,036,800,000
Operating costs		350,000,000	420,000,000	504,000,000	604,800,000	725,760,000
EBITDA		$ 150,000,000	$ 180,000,000	$ 216,000,000	$ 259,200,000	$ 311,040,000
Less: Depreciation		120,000,000
Incremental EBIT		$ 30,000,000	$ 180,000,000	$ 216,000,000	$ 259,200,000	$ 311,040,000
Less: Taxes		10,500,000	63,000,000	75,600,000	90,720,000	108,864,000
NOPAT
Plus: Depreciation
Change in NWC
After-Tax Cash from Asset Sale
FFCF
NPV
IRR
Analysis
b) The marketing and operations department disagree with current projections for operating costs, first year revenues and revenue growth . Considering one factor at a time, at what level of operating costs, initial revenues, and revenues growth the project will break-even (NPV=0)? (see chapter 3 for details)
	Base case	Break-even
Operating costs (% of revenues)	70.00%
Year 1 revenues	$ 500,000,000
Revenues growth (decline)	20.00%
Cash flow estimation	0	1	2	3	4	5
Investment	$ (600,000,000)
Revenues
Operating costs
EBITDA
Less: Depreciation
Incremental EBIT
Less: Taxes
NOPAT
Plus: Depreciation
Change in NWC
Cash from Asset Sale
FFCF
NPV
IRR
Looking at percentage difference between the predicted level and critical (break-even) level of each of the three factors, which of them is the most critical?
	Base case	Break-even	Difference (%)
Operating costs (% of revenues)	70.00%
Year 1 revenues	$ 500,000,000
Revenues growth	20.00%
Your answer.