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Cash Flow Estimation and Risk Analysis Note: WACC (Weighted Average Cost of Capital) is the cost of capital (or discount rate). USE WACC for both financing cost and reinvestment rate to calculate MIRR. Webmasters.com has developed a powerful new server that would be used for corporations' Internet activities. It would cost $10 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 10% of the year's projected sales; for example, NWCo = 10%(Sales). The firm believes it could sell 1,000 units per year. The servers would sell for $24,000 per unit, and Webmasters believes that variable costs would amount to $18,000 per unit. After Year 1, the sales price and variable costs will increase at the inflation rate of 3%. The company's nonvariable costs would be $1 million at Year 1 and also would increase at the 3% inflation rate. The server project would have a life of 4 years. If the project is undertaken, it must be continued for the entire 4 years. 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 $500,000. Webmasters' federal-plus-state tax rate is 25%. 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 a WACC of 8%, and high-risk projects at 13%. Also, the project's returns are expected to be highly correlated with returns on the firm's other assets. 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 Base Case Note: the items in red will be used in a scenario analysis. Probability of scenario 50% Equipment cost $10,000 Net operating working capital/Sales 10% Key Results: First year sales (in units) 1,000 NPV = Sales price per unit $24.00 IRR Variable cost per unit (excl. depr.) $18.00 Payback = Nonvariable costs (excl. depr.) $1,000 Inflation in prices and costs 3.0% Estimated salvage value at year 4 $500 Depreciation years Year 1 Year 2 Year 3 Year 4 Depreciation rates 20.00% 32.00% 19.20% 11.52% Tax rate 25% WACC for average-risk projects 10% 2 3 20.00% 32.00% 19.20% 11.52% Years 2 0 3 4 42 Intermediate Calculations 43 Units sold 44 Sales price per unit (excl. depr.) 45 Variable costs per unit (excl. depr.) 46 Nonvariable costs (excl. depr.) 47 Sales revenue 48 Required level of net operating working capital 49 Basis for depreciation 50 Annual equipment depr. rate 51 Annual depreciation expense 52 Ending Bk Val: Cost - Accum Dep'rn 53 Salvage value 54 Profit (or loss) on salvage 55 Tax on profit (or loss) 56 Net cash flow due to salvage 57 58 Cash Flow Forecast 59 Sales revenue 60 Variable costs 61 Nonvariable operating costs 62 Depreciation (equipment) 63 Oper. income before taxes (EBIT) 64 Taxes on operating income (25%) 65 Net operating profit after taxes 66 Add back depreciation 67 Equipment purchases 68 Cash flow due to change in NOWC 69 Net cash flow due to salvage 70 Net Cash Flow (Time line of cash flows) 71 72 Key Results: Appraisal of the Proposed Project 73 74 Net Present Value (at 10%) = 75 IRR = 76 MIRR = 77 Payback 78 Discounted Payback = 79 Data for Payback Years 80 81 Net cash flow 82 Cumulative CF 83 Part of year required for payback 84 85 86 Data for Discounted Payback Years 87 88 Net cash flow 89 Discounted cash flow 90 Cumulative CF 91 Part of year required for discounted payback 92 Bonus Question Bonus Question Years 2 3 4 Years 2 0 1 3 4 Cash Flow Estimation and Risk Analysis Note: WACC (Weighted Average Cost of Capital) is the cost of capital (or discount rate). USE WACC for both financing cost and reinvestment rate to calculate MIRR. Webmasters.com has developed a powerful new server that would be used for corporations' Internet activities. It would cost $10 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 10% of the year's projected sales; for example, NWCo = 10%(Sales). The firm believes it could sell 1,000 units per year. The servers would sell for $24,000 per unit, and Webmasters believes that variable costs would amount to $18,000 per unit. After Year 1, the sales price and variable costs will increase at the inflation rate of 3%. The company's nonvariable costs would be $1 million at Year 1 and also would increase at the 3% inflation rate. The server project would have a life of 4 years. If the project is undertaken, it must be continued for the entire 4 years. 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 $500,000. Webmasters' federal-plus-state tax rate is 25%. 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 a WACC of 8%, and high-risk projects at 13%. Also, the project's returns are expected to be highly correlated with returns on the firm's other assets. 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 Base Case Note: the items in red will be used in a scenario analysis. Probability of scenario 50% Equipment cost $10,000 Net operating working capital/Sales 10% Key Results: First year sales (in units) 1,000 NPV = Sales price per unit $24.00 IRR Variable cost per unit (excl. depr.) $18.00 Payback = Nonvariable costs (excl. depr.) $1,000 Inflation in prices and costs 3.0% Estimated salvage value at year 4 $500 Depreciation years Year 1 Year 2 Year 3 Year 4 Depreciation rates 20.00% 32.00% 19.20% 11.52% Tax rate 25% WACC for average-risk projects 10% 2 3 20.00% 32.00% 19.20% 11.52% Years 2 0 3 4 42 Intermediate Calculations 43 Units sold 44 Sales price per unit (excl. depr.) 45 Variable costs per unit (excl. depr.) 46 Nonvariable costs (excl. depr.) 47 Sales revenue 48 Required level of net operating working capital 49 Basis for depreciation 50 Annual equipment depr. rate 51 Annual depreciation expense 52 Ending Bk Val: Cost - Accum Dep'rn 53 Salvage value 54 Profit (or loss) on salvage 55 Tax on profit (or loss) 56 Net cash flow due to salvage 57 58 Cash Flow Forecast 59 Sales revenue 60 Variable costs 61 Nonvariable operating costs 62 Depreciation (equipment) 63 Oper. income before taxes (EBIT) 64 Taxes on operating income (25%) 65 Net operating profit after taxes 66 Add back depreciation 67 Equipment purchases 68 Cash flow due to change in NOWC 69 Net cash flow due to salvage 70 Net Cash Flow (Time line of cash flows) 71 72 Key Results: Appraisal of the Proposed Project 73 74 Net Present Value (at 10%) = 75 IRR = 76 MIRR = 77 Payback 78 Discounted Payback = 79 Data for Payback Years 80 81 Net cash flow 82 Cumulative CF 83 Part of year required for payback 84 85 86 Data for Discounted Payback Years 87 88 Net cash flow 89 Discounted cash flow 90 Cumulative CF 91 Part of year required for discounted payback 92 Bonus Question Bonus Question Years 2 3 4 Years 2 0 1 3 4