Nuval Audio Systems (NAS), Inc. is evaluating the market potential of producing and marketing latest version of a voice recognition (VR) computer keyboard. The results of an initial questionnaire that NAS has conducted in major markets six months ago and cost $65,000 were positive. A more comprehensive market test study that will cost an additional $320,000 was just completed and affirmed at least a 40% of the total VR market. NAS has not yet paid for this study.

Now NAS is at the point where it is considering investing in the assets needed to produce the VRs. The VRs would be produced in a building owned by the firm. The building, which was bought by NAS 20 years ago for $120,000, is currently vacant but it can be sold for $295,000. The value of the building on NAS’s books is $64,000. NAS can fully depreciate this $64,000 over the next four years on a straight-line basis. In order to estimate the market value of the building at project’s end, the company assumes that the price change will follow the trend experienced in the last 20 years (i.e. the average growth rate over the last 20 years is used as the growth rate estimate for the coming 10 years). The land on which the building sits was bought for $92,000 twenty years ago and it is valued at $235,000 today. The expected appreciation in the land value is 4.80% per year over the coming ten-year period. NAS assumes that it will be able to sell both the building and the land together at their expected values at the end of the project’s life.

The price of the new equipment needed is $7,600,000. It will require and additional $164,000 in shipping and installation costs. The useful life of the equipment is 12 years but the company intends to use it for only the ten years that is the life of the project and then sell it at the termination of the project. It estimates its salvage value at $1,160,000. Production is estimated to be 46,000 units in the first year, rising by 15% per year for the following six years then falling by 7% per year for the remaining life of the project. The price of the VRs in the first year will be $180. The VR market is highly competitive and NAS believes that the price will increase by 2.40% per year for the life of the project. However, the ingredients used to produce the VRs is rapidly becoming more expensive. Variable production costs that will be $78 per unit in the first year will rise by 9.60% per year for the following five years then by 4.68% per year for the following four years. Total fixed costs excluding depreciation expense is assumed to stay constant at $3,200,000 per year for the life of the project. In addition, NAS is aware of the fact that some of the demand for its new VRs will be the result of shifting demand from its sales of the old VRs. It estimates that the new production will replace 16,000 units per year that bring in an after-tax EBIT of $30 per unit. The marginal tax rate applicable to this project is 28%.

NAS anticipates that it will maintain an investment in working capital equal to $210,000 initially (at time point zero) and rising by 3.24% per year in the first six years then declining by 20% in each of years seven, eight, and nine before is completely recovered in year ten.

NAS uses the straight-line depreciation for all its depreciable assets.

1. On an Excel spreadsheet, estimate the following (Aside from an initial input panel that contains all the parameters given in the question above, all Excel cells must show cell references, no cell outside the input panel should show a numerical value only, i.e. entered manually):
   1. Total initial net cash outlays (show it clearly in one box)
   2. Total after-tax salvage value (ATSV) for all assets (clearly show details for each salvageable asset in another box. Place this box to the right of the initial outlay box)
   3. The annual depreciation schedule.
   4. The annual incremental investment in the NWC schedule
   5. Annual free cash flows (FCF): Show every parameter that goes into the FCF estimates in its own row (quantity units, price, variable cost per unit, etc…)

At this point in the project, assume that the required rate of return on NAS’s projects of similar risk is 17%.

2. Use the capital budgeting criteria and decision rules to decide which ones lead to acceptance of the new project and which ones don’t and why. Show in as much detail as possible on an Excel spreadsheet how you will evaluate the project including all estimates of cash flows and all the necessary calculations. Assume NAS uses a required payback of 6 years or less.

3. NAS is not always comfortable with the estimate of its cost of capital so it uses sensitivity analysis to check how robust its project valuations to various estimates of the cost of capital. The estimate should start with 0% and increase by increments of 5% points until it reaches 30%. For each estimate, an NPV is calculated to analyze the sensitivity of NPV to various discount rate assumptions. Plot the NPV profile (NPV on the y-axis and discount rates on the x-axis). Watch where the NPV curve intersects with the x-axis. What do you call the intersection point?