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Cloud Nine considers selling anew system, which move all customer's applications to the cloud. The management anticipates that new system will have the first yearrevenues of$25,750 K with subsequent annual revenuegrowthof 5%. Operating costs are 60% of revenues.The project requires $35 Milinvestment in equipment, which will have a five year anticipated life and willbe depreciated using three yearMACRS depreciation method toward a zero book value (three year MACRS official;depreciation rates are given below - it does require 4 years, this is not a typo!).However, the company will be able to sell the equipment on the after-market atthe end of year 5 for 10% ofits original cost. The company requires an 8% rateof return from its investment and faces a 40% taxrate (overall the company is profitable). Inaddition 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 $5,150 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 departmentdisagree with current projectionsfor operating costs, first year revenues and revenue growth . Considering one factor at a time, at whatlevel 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? (see chapter 3 for details)

PROBLEM 2 Cloud Nine considers selling a new system, which move all customer's applications to the cloud. The management anticipates that new system will have the first year revenues of $25,750 K with subsequent annual revenue growth of 5%. Operating costs are 60% of revenues. The project requires $35 Mil investment in equipment, which will have a five year anticipated life and will be depreciated using three year MACRS depreciation method toward a zero book value (three year MACRS official; depreciation rates are given below - it does require 4 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 10% of its original cost. The company requires an 8% rate of return from its investment and faces a 40% 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 $5,150 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? (see chapter 3 for details) Investment cost (today) Project Life Net Working Capital Year 1 revenues Operating costs After-market value Revenue annual growth Required rate of return Tax rate Given $ (35,000,000) 5 years 20.00% of revenues $ 25,750,000 60.00% of revenues 10% of initial investment 5.00% 8.00% 40% MACRS Depreciation: Year 1 Year 2 Year 3 Year 4 33.33% 44.45% 14.81% 7.41% Solution a. Year Cash flow estimation Investment Revenues Operating costs EBITDA Less: Depreciation Incremental EBIT Less: Taxes NOPAT Plus: Depreciation Change in NWC Cash from Asset Sale FFCF 0 $ (35,000,000) 1 2 3 4 5 (5,150,000) Score NPV IRR Analysis b) The marketing and operations department disagree with current projections for operating costs, first year revenues and revenue growth . b. 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) Operating costs (% of revenues) Year 1 revenues Revenues growth (decline) Base case Break-even 60.00% $ 25,750,000 5.00% Using Goal Seek Your Score Maximum 5 Maximum 7 Feel free to add extra rows if necessary 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? Your Score Maximum 3 Operating costs (% of revenues) Year 1 revenues Revenues growth Your answer. Base case Break-even 60.00% $ 25,750,000 5.00% Difference (%) Solution Legend Value given in problem Formula/Calculation/Analysis required Qualitative analysis or Short answer required Goal Seek or Solver cell Score (filled by professor)