Problem Two: Capital Budgeting (USE SHEET LABELED PROBLEM TWO)

An enterprising online retailer is trying to determine whether to expand their service by investing in a new computing server. The new server, with expanded capacity and software development, is expected to allow the retailer to accommodate website traffic and increasing demand for their online services. In all, the initial investment costs $25,000, and incurs an additional 3.5% of sales in server maintenance costs.

The new server can be depreciated using a 7 year MACRS schedule. The project will required an initial investment in NWC of $2,000. The manager has forecasted the following new sales for the first year:

Year 1

New Goods Sold 5,000

Average Price per Good $3.00

The manager expects for the number of goods sold each year to increase by 10%, and he will also increase the average price per good by 5% each year. The cost of goods is expected to be 15% of sales, and selling expenses will be 10% of sales on the product. The project will be evaluated over 5 years. The manager believes he could sell the server for $3,000 at that point if needed.

The manager notes that accounts receivables and accounts payables are 20% and 30% of sales respectively. The retailer also projects inventory will remain at 15% of sales each year. The cost of capital for the retailer is 15% for all new projects. The tax rate for the firm is 35%.

OBJECTIVES:

1. Find the Project Cash Flows by filling out the budgeting model. Use these cash flows to find NPV and IRR. Your project cash flows should include at least the following: (Revenue, COGS, Gross Profit, All expenses, Depreciation, Investment in NWC, Investment in Gross PPE (CAPEX), and any recovered cash flows at the end of the project).

2. On the same sheet, lets conduct sensitivity analysis. Create a two-way data table that shows the NPV as a function of the annual goods growth rate and cost of goods sold as a % of sales.

3. On another sheet, find the most that the start-up cost (CAPEX or gross PPE) can be for the project and still break even.