Answered step by step
Verified Expert Solution
Question
1 Approved Answer
The consulting firm you work for on your work term just signed up a new client, Microsoft Corporation ( MSFT ) . Your supervisor is
The consulting firm you work for on your work term just signed up a new client, Microsoft Corporation MSFT Your supervisor is now in charge of this account, so we will be busy helping her.
Your first assignment is to determine the free cash flows and net present value NPV of a proposed Microsoft Surface tablet computer similar in size to an iPad but with the operating power of a highend desktop system.
Development of the new system will initially require an initial capital expenditure equal to of Microsofts Property, Plant, and Equipment PPE at the end of the latest fiscal year for which data are available. The project will then require an additional investment equal to of the initial investment in the project's first year and of the initial investment in the second year. The product is expected to have a life of five years. Firstyear revenues for the new product are expected to be of Microsofts total revenue for the latest fiscal year for which data are available. The new products revenues are expected to grow at for the second year, then for the third and annually for the final two years of the project's expected life. Your job is to determine the rest of the cash flows associated with this project. Your supervisor has indicated that the operating costs and net working capital requirements are similar to the rest of the company and that depreciation is straightline for capital budgeting purposes.
Obtain Microsots financial statements. Your supervisor recommended downloading the latest annual income statements, balance sheets, and cash flow statements from Morningstar wwwmorningstar.com Enter Microsoft's ticker symbol and then go to Financials Download the annual as originally reported financial statements.
Estimate the Free Cash Flow for the new product. Compute the Free Cash Flow for each year using the following equation:
Where
is the corporate tax rate,
is the capital expenditure, and
NWC is the change in net working capital.
Set up the timeline and computation of free cash flow in separate, contiguous columns for each year of the project life. Be sure to make outflows negative and inflows positive.
Assume that the projects profitability will be similar to Microsoft's existing projects in the latest fiscal year and estimate revenues costs each year using the latest Earnings Before Interest, Taxes, Depreciation and Amortization EBITDASales profit margin.
Determine the annual depreciation by assuming Micorosft depreciates these assets by the straightline method over five years. Assume $ salvage value
Determine Microsofts tax rate using the current US federal corporate income tax rate.
Calculate the net working capital required each year by assuming that the level of NWC will be a constant percentage of the projects sales. Use Microsoft's NWCSales for the latest fiscal year to estimate the required percentage. Use only accounts receivable, accounts payable and inventory to measure working capital. Other current assets and liabilities components are harder to interpret and not necessarily reflective of the required NWC for this project.
To determine the free cash flow, deduct the additional capital investment and the change in net working capital each year.
Calculate the NPV of the project with a cost of capital. Next, calculate the project's internal rate of return IRR
Perform a sensitivity analysis on NPV by varying the cost of capital from to
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started