Suppose Apple has decided to introduce a smart TV, the Cortland. Before they launch the Cortland, they conducted an analysis to see if the Cortland would be a desirable investment. The company estimated that it would sell 1 million Cortlands per year at a price of $3,200 for the next six years. The initial capital outlay is determined to be $1.5 billion and a $700 million outlay in net working capital (NWC) would also be required. Assume that there is a one-time investment in NWC and that this will be recovered at the end of the project. Assume that the equipment used will be depreciated using the MACRS 7 year schedule and that the equipment has a salvage value of zero. At the end of year 6, the equipment will be sold for its book value. Also, assume that that the tax rate is 21%.

Using information from Apples financial statements (you may want to use Morningstar.com or some other online site) estimate the operating cash flows from the project. Make any simplifying assumptions that are necessary to produce the estimate.

Cost of Capital

We now need to estimate Apples cost of capital in order to continue our analysis of the project.

Use the 10 year Treasury Bond rate as the risk free rate and assume that the market risk premium is 7% to find Apples cost of equity. Assume that Apples bonds are rated AAA and that Apples corporate tax rate is 21%. Assume that Apples bonds have no floatation costs, but the cost of issuing equity is 3%. Find Apples weighted average cost of capital. Assume that the project will be financed with internal funds. You will need to find additional financial information from the Wall Street Journal and online at sites likehttp://finance.yahoo.com to complete your calculation.

Using the spreadsheet you constructed in the first problem and the cost of capital calculations you computed in the second problem to determine if Apple should continue with the Cortland project. Use the following capital budgeting techniques.

1. Payback period

2. Net present value

3. Internal rate of return

Now lets test the sensitivity of the project to some changes in the assumptions.

4. Take the cost of capital you previously computed (in week 8) and add 4% to the value (for example, if WACC was 12%, make it 16%) and recalculate NPV. What happens to IRR? Is the project still desirable?

5. Suppose the cost of goods sold percentage rises by 2%. Compute the payback period, NPV and IRR. Use the original WACC you computed.

6. How sensitive is NPV to the changes made in 4 and 5?