Pinto.com has developed a powerful new server that would be used for corporations' Internet activities. It would cost $25 million at Year 0 to buy the equipment necessary to manufacture the server. The project would require net working capital at the beginning of each year in an amount equal to 12% of the year's projected sales; for example, NWC₀= 12%(Sales₁). The servers would sell for $21,000 per unit, and Pinto believes that variable costs would amount to $15,000 per unit. After Year 1, the sales price and variable costs will increase at the inflation rate of 2.5%. The company's nonvariable costs would be $1.5 million at Year 1 and would increase with inflation. The server project would have a life of 4 years. If the project is undertaken, it must be continued for the entire 4 years. Also, the project's returns are expected to be highly correlated with returns on the firm's other assets. The firm believes it could sell 2,000 units per year. The equipment would be depreciated over a 5-year period, using MACRS rates. The estimated market value of the equipment at the end of the project's 4-year life is $1 million. Pinto.com's federal-plus-state tax rate is 20%. Its cost of capital is 10% for average-risk projects, defined as projects with a coefficient of variation of NPV between 0.8 and 1.2. Low-risk projects are evaluated with an 8% project cost of capital and high-risk projects at 13%.

1. Develop a spreadsheet model, and use it to find the project's NPV, IRR, and payback.
2. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and number of units sold. Set these variables' values at 10% and 20% above and below their base-case values.
3. Now conduct a scenario analysis. Assume that there is a 25% probability that best-case conditions, with each of the variables discussed in Part b being 20% better than its base-case value, will occur. There is a 25% probability of worst-case conditions, with the variables 20% worse than base, and a 50% probability of base-case conditions.
4. If the project appears to be more or less risky than an average project, find its risk-adjusted NPV, IRR, and payback.
5. On the basis of information in the problem, would you recommend the project should be accepted?

Chapter 11 - Build a Model.xlsx Q Search Sheet Home Insert Page Layout Formulas Data Review View '+ Share M80 X V fx B C D E F G H 11 I Chapter: J K L M N P Q s T U V w X Y Z AA Cash Flow Estimation and Risk Analysis AB AC AD AE AF AWN a. Develop a spreadsheet model, and use it to find the project's NPV, IRR, and payback. Input Data (in thousands of dollars Scenario name Probability of scenario Base Case Note: the items in red will be used in a scenario analysis. 50% Equipment cost 9 Net operating working capital/Sales $25,000 12% 10 First year sales (in units) Key Results: 11 Sales price per unit 2,000 $21.00 NPV = 12 Variable cost per unit (excl. depr.) IRR = $15.00 13 Nonvariable costs (excl. depr.) $1,500 Payback = 14 Inflation in prices and costs 2.5% 15 Estimated salvage value at year 4 16 Depreciation years $1,000 Year 1 17 Depreciation rates 20.00% Year 2 Year 3 32.00% Year 4 19.20% 11.52% Tax rate 20% 19 WACC for average-risk projects 10% 20 21 Intermediate Calculations Units sold 23 Sales price per unit (excl. depr.) 24 Variable costs per unit (excl. depr.) 25 Nonvariable costs (excl. depr.) 26 Sales revenue 27 Required level of net operating working capital 28 Basis for depreciation 29 Annual equipment depr. rate 30 Annual depreciation expense 20.00% 32.00% 19.20% 11.52% 31 Ending Bk Val: Cost - Accum Dep'rn 32 Salvage value 33 Profit (or loss) on salvage 34 Tax on profit (or loss) 36 35 Net cash flow due to salvage Cash Flow Forecast Years 38 Sales revenue 39 Variable costs 40 Nonvariable operating costs 41 Depreciation (equipment) 42 Oper. income before taxes (EBIT) 43 Taxes on operating income (20% 44 Net operating profit after taxes 45 Add back depreciation 46 Equipment purchases 47 Cash flow due to change in NOWC 48 Net cash flow due to salvage 50 49 Net Cash Flow (Time line of cash flows) 52 51 Key Results: Appraisal of the Proposed Project 53 Net Present Value (at 10%) = 54 IRR = 55 MIRR = 56 Payback = 57 Discounted Payback = 59 58 Data for Payback Years Years 2 60 Net cash flow 62 Cumulative CF 63 Part of year required for payback 64 65 Data for Discounted Payback Years 898 Years Net cash flow SO SO 69 Discounted cash flow SO 70 Cumulative CF Part of year required for discounted payback Build a Model + Ready 100%