The question and answer is provided below. Can someone please summarize in a few paragraphs the steps, justifications, and the "why's" in this case study?

Case:

You have just been hired by Internal Business Machines Corporation (IBM) in their capital budgeting division. Your first assignment is to determine the free cash flows and NPV of a proposed new type of tablet computer similar in size to an iPad but with the operating power of a high-end desktop system. Please read the descriptions given in the case for all the details you will need for your analysis. Using that information, make capital budgeting model in the same or similar way, as described in the chapter, using Excel.

Your Analysis Should Clearly Answer the Following Questions:

1. (5 Points)Obtain IBM's financial statements. (If you really worked for IBM you would already have this data, but at least you will not get fired if your analysis is off target.) Download the annual income statements, balance sheets, and cash flow statements for the last four fiscal years from Yahoo! Finance (finance.yahoo.com). Enter IBM's ticker symbol and then go to "financials."

2. (Total 30 Points)You are now ready to estimate the Free Cash Flow for the new product. Compute the Free Cash Flow for each year using Eq. 8.5:

FreeCashFlow = (Revenues - Costs - Depreciation) * (1 - tc) + Depreciation - CapEx - NWC

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.

a. (5 Points) Assume that the project's profitability will be similar to IBM's existing projects in the latest fiscal year and estimate (revenues - costs) each year by using the latest EBITDA/Sales profit margin. Calculate EBITDA as EBIT plus Depreciation expense from the cash flow statement

b. (5 points) Determine the annual depreciation by assuming that IBM depreciates these assets by the straightline method over a five-year life.

c. (3 Points) Determine IBM's tax rate by using the current U.S. federal corporate income tax rate.

d. (7 Points) Calculate the net working capital required each year by assuming that the level of NWC will be a constant percentage of the project's sales. Use IBM's NWC/Sales for the latest fiscal year to estimate the required percentage. (Use only accounts receivable, accounts payable, and inventory to measure working capital. Other components of current assets and liabilities are harder to interpret and not necessarily reflective of the project's required NWCfor example, IBM's cash holdings.)

e. (5 points) To determine the free cash flow, deduct the additional capital investment and the change in net working capital each year.

f. (3 points) Use Excel to determine the NPV of the project using 12% as cost of capital.

g. (2 Points) What is the IRR of the project?

Total 15 Points) Perform a sensitivity analysis by varying the project forecasts as follows:

1. (5 Points) Suppose first year sales will equal 2%-4% of IBM's revenues.
2. (5 Points) Suppose the cost of capital is 10%-15%.
3. (5 points) Suppose revenue growth is constant after the first year at a rate of 0%-10%.

Please do the analysis using the Excel spreadsheet. Please submit the spreadsheet showing your analysis. In the spreadsheet, highlight the answers to the questions asked above. Based on your analysis, please also submit a justificationfor any assumptions you made.

Answer:

ear 1Year 2Year 3Year 4Year 5Revenues27837903201359352149436975693882448Op Cost21797082506664275733028951973039956Op Profit604082694695764164802372842491Depreciation215420236962259581282426305500PBT388662457733504583519946536991Tax82357.696993.6106921110177113788PAT306305360739397662409770423203CF521725597701657243692196728703(PAT + Depreciation)

1. Free Cash Flow = (Revenues - Costs - Depreciation) x (1 - c) + Depreciation - CapEx - NWC

YearInitial InvestmentChange in NWCCash FlowsFree Cash FlowsDF @12%PV0-10771000-1077100-10771001-10771001-107710-217135.62521724.86196879.240.8931757852-113095.5-249705.96597701.22234899.760.797187260.63-114226.46-274676.56657243.1268340.090.712190999.24-115368.72-288410.39692195.91288416.80.636183294.15-116522.41-302830.91728702.72309349.410.567175533.2NPV-164228

In the lowest Cost of Capital and the Highest Consistent Sales growth of 10% also NPV is coming as -131230.

The main assumptions are Depreciation calculated as per Straight Line Method for 5 years for Initial Investment too not for the remaining life of the project. It is not getting clear from the question.

1. 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.

YearFree Cash Flows0-10771001196879.242234899.763268340.094288416.85309349.41

1. Assume that the projects profitability will be similar to IBMs existing projects in the latest fiscal year and estimate (revenues - costs) each year by using the latest EBITDA/Sales profit margin. Calculate EBITDA as EBIT + Depreciation expense from the cash flow statement.

EBIT- 5925000

Depreciation-6695000

EBITDA= 5925000+6695000

=12,620,000

1. Determine the annual depreciation by assuming IBM depreciates these assets by the straightline method over a five-year life.

Total assets 155,971,000/5

=31,194,200

1. Determine IBMs tax rate by using the current U.S. federal corporate income tax rate.

Pretax income 4637000

Tax provision 864000

Tax provision/Tax income

864000/4637000

=18.6327%

1. 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 IBMs NWC/Sales for the latest fiscal year to estimate the required percentage. (Use only accounts receivable, accounts payable, and inventory to measure working capital. Other components of current assets and liabilities are harder to interpret and not necessarily reflective of the projects required NWCfor example, IBMs cash holdings.)

Net working capital2020201920182017Current assets39,165,000.0038,420,000.0049,146,000.0049,735,000.00Less accounts payable39,869,000.0037,701,000.0038,227,000.0037,363,300.00(704,000.00)719,000.0010,919,000.0012,371,700.00

1. To determine the free cash flow, deduct the additional capital investment and the change in net working capital each year.

Free cash flow2020201920182017Working capital704,000.00719,000.0010,919,000.0012,372,000.00Invested capital82,135,000.0083,740,000.0062,608,000.0064,417,000.00Free cash flow(81,431,000.00)(83,021,000.00)(51,689,000.00)(52,045,000.00)

1. Use Excel to determine the NPV of the project with a 12% cost of capital. Also calculate the IRR of the project using Excel's IRR function.

Current PPE- 116807000

10%*116807000

11680700

Since the NPV is positive this means the investment is profitable

YearCashflowCost of capitalInitial investmentPresent valuesYear 0-116807001168070020171295100012%11,563,392.8620181128300012%8,994,738.5220191186300012%8,443,849.0820201515500012%9,631,276.4838,633,256.94NPV26,952,556.94IRR100%

1. Perform a sensitivity analysis by varying the project forecasts as follows: Suppose first year sales will equal 2%-4% of IBM's revenues.

This will increase the gross profit

1. Suppose the cost of capital is 10%-15%.

An increase in cost of capital to 15% will reduce the NPV- profits realized

1. Suppose revenue growth is constant after the first year at a rate of 10%.

A constant revenue growth will decrease the net profit realized because materials and consumables keep on increasing as revenue is constant