y M W % 11 AutoSave OFF OFF AS SUDE Ch11 P18 Build a Model (1) Home Insert Draw Page Layout Formulas Data Review View Tell me Share Comments X Arial VA 10 > 25 Wraa Text Insert v Number v LG X Delete Pagic - A Merge & Center Conditional Format Cell Sort Find & Ideas Sensitivity Formatting as Table Styles Format v Filter Select Ag fx b. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and number of units sold. Set these variables' values at 10% and 20% above and below their A B C G H 1 N 0 0 P 2 R 5 u w X 1 Solution 8/13/15 2 Chapter: 11 Estimating Cash Flows and Analyzing Risk 3 Problem: 18 4 5 Webmasters.com has developed a powerful new server that would be used for corporations Internet activities. It would E Gost $10 million at Year 0 to buy the equipment necessary to manufacture the server. The project would require net 7 working capital at the beginning of each year in an amount equal to 10% of the year's projected sales; for example, NWC- 10% (Sales, The servers would sell for $24,000 per unit, and Webmasters believes that variable costs would amount to 10 $17,500 per unit After Year 1, the sales price and variable costs will increase at the inflation rate of 3%. The company's nonvariable costs would be $1 million at Year 1 and would increase with inflation 11 12 The server project would have a life of 4 years. If the project is undertaken, it must be continued for the entire 4 years. Also, the project's rebums are expected to be highly correlated with returns on the firm's other assets. The firm believes it could sell 1,000 units per year. 16 17 10 The equipment would be depreciated over a 5-year period, using MACRS rates. The estimated market value of the equipment at the end of the projects 4-year life is $500,000. Webmasters' federal-plus-state tax rate is 40%. Its cost of capital is 10% for average-risk projects, defined as projects with a coctficient of variation of NPV between 0.8 and 1.2. 20 Low risk projects are evaluated with a WACC of 8%, and high-risk projects at 13%. 21 22 .. Develop a spreadsheet model, and use it to find the project's NPV, IRR, and payback. 23 24 Input Data (in thousands of dollars) 25 Equipment Cont $10,000 Kay Results: 2e Net operating working capital Sales NPV - 27 First year sales in units 1,000 28 Sales price per unit 524.00 Payback = 28 Variable cont per unit (excl. depr.) $17.50 30 Nonvariable costs excl. dopr. $1,000 31 Market value of equipment at Year 4 $500 32 Tax rate 40% 39 WACC 10% 34 Inflation in prices and conts 3.0% 35 Estimated salvage value at year 4 $600 36 37 Intermediate Calculatians 0 1 2 3 4 38 Units sald 39 Sales price per unit (excl. dopr. 40 Variable costs per unit (excl. dopr.) 41 Nonvariable costs excl. depr. 42 SALAR revenue 43 Required level of net operating working capital 44 Basis for depreciation $10.000 45 Annual equipment depr. rate 20.00% 32.00% 19.20% 11.52% 46 Anual depreciation expand 47 Ending Bk Val: Cost - Accum Depirn $10.000 48 Salvace value Build a Model + 5500 Select destination and press ENTER or cheese Paste + 100% AutoSave OFF OFF AS Ch11 P18 Build a Model (1) EVATOO Y F R W X Home Insert Draw Page Layout Formulas Data Review View Tell me Share Comments X Arial VA > v 10 Insert v ah Wrag Text Number v LE X Delete Paste A Conditional Format Merge & Center B 1 Sort Cell Ideas Find & Sensitivity Formatting as Table Styles Format v v Filter Select A89 X fx b. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and number of units sold. Set these variables' values at 10% and 20% above and below their A D F G H 1 . L M N a P S . U 37 Intermediate Caleators 0 1 2 $ 3 4 38 Units sold 39 Sales price per unit (excl. depr.) 40 Variable costs per unit fexcl. depr.) 41 Nonvariable costs axel. depr. 49 Salas revenue 43 Required level of net operating working capital 44 Basis for depreciation $10,000 45 Annual equipment depr. rate 20.00% 32.00% 19.20% 11.52% 46 Annual depreciation expense 47 Ending Bk Val: Cost - Accum Dep'in $10,000 48 Salvage value $500 49 Profit (or loss) on salvage 50 Tax on profit (or losa) 51 Netcash flow due to salvage Years 53 Cash Flow Forecast 3 54 Sales revenus 55 Variable costs SC Nonvariable operating costs 57 Depreciation equipment) 58 Oper. income before taxes (EBIT) se Taxes on operating income (40%) 60 Net operating profit after taxes 61 Add back depreciation 82 Equipment purchases 63 Cash flow due to change in NOWC 64 Net cash now due to salvage 65 Net Cash Flow (Time line of cash flows) fit 87 Key Results: Appraisal of the Proposed Project 69 Not Present Value (at 10%) = 70 IRR 71 MIRR- 72 Payback 73 Discounted Payback = 74 Data for Payback Years Years 75 0 1 2 $ 4 ye Net cash flow 77 Cumulative CF 78 Part of year required for payback 79 52 1 2 4 BU Years 2 0 1 3 11 Data for Discounted Payback Years 82 89 Net cash flow 04 Discounted cash flow Cumulative CF RE Part of your required for discounted payback Build a Model + Select destination and press ENTER or chcase Paste --- + 100% AutoSave OFF OFF AS SUDE Ch11 P18 Build a Model (1) AY Y D 0 Home Insert Draw Page Layout Formulas Data Review View Tell me Share Comments X Arial VA > v 10 25 Wraa Text Insert v Number v LE X Delete Paste A Merge & Center Conditional Format Cell Ideas Sort Find & Sensitivity Formatting as Table Styles Format v v Filter Select Ag X fx b. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and number of units sold. Set these variables' values at 10% and 20% above and below their B G H 1 N o R T V X 72 Payback 73 Discounted Payback 74 Data for Payback Years Years 75 0 1 7C Net cash flow 77 Cumulative CF 79 Part of year required for payback 79 UC 81 Data for Discounted Payback Years Years AP 0 1 2 3 Net cash flow 04 Discounted cash flow 85 Cumulative CF RE Part of year required for discounted payback 87 De hanges in the sales price, variable costs per BS 6. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per 90 unit, and number of units sold Bat these variables' values At 10% and 20% above and below their basecase values 91 Vacude. L srabirouran ----------- 92 X Deviation SALES PRICE from Note about data tables. The data in the column input should NOT 94 BARS NPV 95 Base Case $24.00 be input using a cell reference to the column inputcall. For example, the base Gase Sales Price in Cell 095 should be the -20% number $24.00 you should NOT have the formula =D28 in that cell 97 -10% This is because you'll use D28 as the column input call in the data 98 0% table and if Excel tries to iteratively replace Cell D28 with the 99 10% 100 20% formula-028 rather than a series of numbers, Excel will calculate 101 the wrong answer. Unfortunately, Excel won't tell you that there is 102 a problem, so you'll just get the wrong values for the data table 103 104 % Deviation VARIABLE COST % Deviation 1st YEAR UNIT SALES 105 from Basel NPV from Base NPV 106 Base Case $17.50 Base Case 1,000 107 -20% -20% 108 -10% -10% 109 0% 05S 110 10%S 10% 111 20% 20% 119 113 115 116 117 118 119 120 Build a Model + Select destination and press ENTER or choose Paste + 100% AutoSave OFF OFF AS SUDE Ch11 P18 Build a Model (1) Home Insert Draw Page Layout Formulas Data Review View Tell me Share Comments X LE Paste Y Arial 10 VA 25 Wraa Text Number v > Insert v Delete B 1 Merge & Center Conditional Format Cell Sort Find & Ideas Sensitivity Formatting as Table Styles Format v v Filter Select fx b. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and number of units sold. Set these variables' values at 10% and 20% above and below their B C G N 0 o P 2 R 5 V A89 . A T W 193 134 Coat Unit 136 136 Deviation NPY at Different Deviations from Base 137 fram Variable 198 Base Casal Price Units Sold 139 20% SO $0 $0 140 -10% $0 $0 $0 141 Ox $o $0 | 50 142 10% SO SO SU 143 20% $0 $0 $0 144 145 Rango 148 147 148 c. Now conduct a scenario analysis. Assume that there is a 25% probability that best-case conditions, with each of the 149 variables discussed in Part b being 20% better than its base-case value, will occur. There is a 25% probability of worst 150 case conditions, with the variables 20% worse than base, and a 50% probability of base-case conditions. 151 152 153 154 Bales Unit Variable 155 Scenario Probability Prics Sales Costa NPV 15 Best Case Base Case Worst Case 25% % 50% 25% $28.80 $24.00 $19.20 1,200 1,000 800 $14.00 $17.30 $21.00 157 158 159 160 181 162 163 184 185 Expected NPV- Standard Deviation Coefficient of Variation = Std Dev! Expected NPV = 166 d. If the project appears to be more or less risky than an average project, find its risk-adjusted NPV, IRR, and payback. 187 168 CV range of firm's average risk project: 0.8 to 1.2 169 Low-risk WACC = 8% 170 WACC - 10% 171 High-risk WACC - 13% 172 173 Risk-adjusted WACC = 174 Risk adjusted NPV - 175 IRR - 176 Payback 178 . On the basis of information in the problem, would you recommend that the project be accepted? 179 Build a Model + + Select destination and press ENTER or choose Past E- + 100% y M W % 11 AutoSave OFF OFF AS SUDE Ch11 P18 Build a Model (1) Home Insert Draw Page Layout Formulas Data Review View Tell me Share Comments X Arial VA 10 > 25 Wraa Text Insert v Number v LG X Delete Pagic - A Merge & Center Conditional Format Cell Sort Find & Ideas Sensitivity Formatting as Table Styles Format v Filter Select Ag fx b. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and number of units sold. Set these variables' values at 10% and 20% above and below their A B C G H 1 N 0 0 P 2 R 5 u w X 1 Solution 8/13/15 2 Chapter: 11 Estimating Cash Flows and Analyzing Risk 3 Problem: 18 4 5 Webmasters.com has developed a powerful new server that would be used for corporations Internet activities. It would E Gost $10 million at Year 0 to buy the equipment necessary to manufacture the server. The project would require net 7 working capital at the beginning of each year in an amount equal to 10% of the year's projected sales; for example, NWC- 10% (Sales, The servers would sell for $24,000 per unit, and Webmasters believes that variable costs would amount to 10 $17,500 per unit After Year 1, the sales price and variable costs will increase at the inflation rate of 3%. The company's nonvariable costs would be $1 million at Year 1 and would increase with inflation 11 12 The server project would have a life of 4 years. If the project is undertaken, it must be continued for the entire 4 years. Also, the project's rebums are expected to be highly correlated with returns on the firm's other assets. The firm believes it could sell 1,000 units per year. 16 17 10 The equipment would be depreciated over a 5-year period, using MACRS rates. The estimated market value of the equipment at the end of the projects 4-year life is $500,000. Webmasters' federal-plus-state tax rate is 40%. Its cost of capital is 10% for average-risk projects, defined as projects with a coctficient of variation of NPV between 0.8 and 1.2. 20 Low risk projects are evaluated with a WACC of 8%, and high-risk projects at 13%. 21 22 .. Develop a spreadsheet model, and use it to find the project's NPV, IRR, and payback. 23 24 Input Data (in thousands of dollars) 25 Equipment Cont $10,000 Kay Results: 2e Net operating working capital Sales NPV - 27 First year sales in units 1,000 28 Sales price per unit 524.00 Payback = 28 Variable cont per unit (excl. depr.) $17.50 30 Nonvariable costs excl. dopr. $1,000 31 Market value of equipment at Year 4 $500 32 Tax rate 40% 39 WACC 10% 34 Inflation in prices and conts 3.0% 35 Estimated salvage value at year 4 $600 36 37 Intermediate Calculatians 0 1 2 3 4 38 Units sald 39 Sales price per unit (excl. dopr. 40 Variable costs per unit (excl. dopr.) 41 Nonvariable costs excl. depr. 42 SALAR revenue 43 Required level of net operating working capital 44 Basis for depreciation $10.000 45 Annual equipment depr. rate 20.00% 32.00% 19.20% 11.52% 46 Anual depreciation expand 47 Ending Bk Val: Cost - Accum Depirn $10.000 48 Salvace value Build a Model + 5500 Select destination and press ENTER or cheese Paste + 100% AutoSave OFF OFF AS Ch11 P18 Build a Model (1) EVATOO Y F R W X Home Insert Draw Page Layout Formulas Data Review View Tell me Share Comments X Arial VA > v 10 Insert v ah Wrag Text Number v LE X Delete Paste A Conditional Format Merge & Center B 1 Sort Cell Ideas Find & Sensitivity Formatting as Table Styles Format v v Filter Select A89 X fx b. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and number of units sold. Set these variables' values at 10% and 20% above and below their A D F G H 1 . L M N a P S . U 37 Intermediate Caleators 0 1 2 $ 3 4 38 Units sold 39 Sales price per unit (excl. depr.) 40 Variable costs per unit fexcl. depr.) 41 Nonvariable costs axel. depr. 49 Salas revenue 43 Required level of net operating working capital 44 Basis for depreciation $10,000 45 Annual equipment depr. rate 20.00% 32.00% 19.20% 11.52% 46 Annual depreciation expense 47 Ending Bk Val: Cost - Accum Dep'in $10,000 48 Salvage value $500 49 Profit (or loss) on salvage 50 Tax on profit (or losa) 51 Netcash flow due to salvage Years 53 Cash Flow Forecast 3 54 Sales revenus 55 Variable costs SC Nonvariable operating costs 57 Depreciation equipment) 58 Oper. income before taxes (EBIT) se Taxes on operating income (40%) 60 Net operating profit after taxes 61 Add back depreciation 82 Equipment purchases 63 Cash flow due to change in NOWC 64 Net cash now due to salvage 65 Net Cash Flow (Time line of cash flows) fit 87 Key Results: Appraisal of the Proposed Project 69 Not Present Value (at 10%) = 70 IRR 71 MIRR- 72 Payback 73 Discounted Payback = 74 Data for Payback Years Years 75 0 1 2 $ 4 ye Net cash flow 77 Cumulative CF 78 Part of year required for payback 79 52 1 2 4 BU Years 2 0 1 3 11 Data for Discounted Payback Years 82 89 Net cash flow 04 Discounted cash flow Cumulative CF RE Part of your required for discounted payback Build a Model + Select destination and press ENTER or chcase Paste --- + 100% AutoSave OFF OFF AS SUDE Ch11 P18 Build a Model (1) AY Y D 0 Home Insert Draw Page Layout Formulas Data Review View Tell me Share Comments X Arial VA > v 10 25 Wraa Text Insert v Number v LE X Delete Paste A Merge & Center Conditional Format Cell Ideas Sort Find & Sensitivity Formatting as Table Styles Format v v Filter Select Ag X fx b. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and number of units sold. Set these variables' values at 10% and 20% above and below their B G H 1 N o R T V X 72 Payback 73 Discounted Payback 74 Data for Payback Years Years 75 0 1 7C Net cash flow 77 Cumulative CF 79 Part of year required for payback 79 UC 81 Data for Discounted Payback Years Years AP 0 1 2 3 Net cash flow 04 Discounted cash flow 85 Cumulative CF RE Part of year required for discounted payback 87 De hanges in the sales price, variable costs per BS 6. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per 90 unit, and number of units sold Bat these variables' values At 10% and 20% above and below their basecase values 91 Vacude. L srabirouran ----------- 92 X Deviation SALES PRICE from Note about data tables. The data in the column input should NOT 94 BARS NPV 95 Base Case $24.00 be input using a cell reference to the column inputcall. For example, the base Gase Sales Price in Cell 095 should be the -20% number $24.00 you should NOT have the formula =D28 in that cell 97 -10% This is because you'll use D28 as the column input call in the data 98 0% table and if Excel tries to iteratively replace Cell D28 with the 99 10% 100 20% formula-028 rather than a series of numbers, Excel will calculate 101 the wrong answer. Unfortunately, Excel won't tell you that there is 102 a problem, so you'll just get the wrong values for the data table 103 104 % Deviation VARIABLE COST % Deviation 1st YEAR UNIT SALES 105 from Basel NPV from Base NPV 106 Base Case $17.50 Base Case 1,000 107 -20% -20% 108 -10% -10% 109 0% 05S 110 10%S 10% 111 20% 20% 119 113 115 116 117 118 119 120 Build a Model + Select destination and press ENTER or choose Paste + 100% AutoSave OFF OFF AS SUDE Ch11 P18 Build a Model (1) Home Insert Draw Page Layout Formulas Data Review View Tell me Share Comments X LE Paste Y Arial 10 VA 25 Wraa Text Number v > Insert v Delete B 1 Merge & Center Conditional Format Cell Sort Find & Ideas Sensitivity Formatting as Table Styles Format v v Filter Select fx b. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and number of units sold. Set these variables' values at 10% and 20% above and below their B C G N 0 o P 2 R 5 V A89 . A T W 193 134 Coat Unit 136 136 Deviation NPY at Different Deviations from Base 137 fram Variable 198 Base Casal Price Units Sold 139 20% SO $0 $0 140 -10% $0 $0 $0 141 Ox $o $0 | 50 142 10% SO SO SU 143 20% $0 $0 $0 144 145 Rango 148 147 148 c. Now conduct a scenario analysis. Assume that there is a 25% probability that best-case conditions, with each of the 149 variables discussed in Part b being 20% better than its base-case value, will occur. There is a 25% probability of worst 150 case conditions, with the variables 20% worse than base, and a 50% probability of base-case conditions. 151 152 153 154 Bales Unit Variable 155 Scenario Probability Prics Sales Costa NPV 15 Best Case Base Case Worst Case 25% % 50% 25% $28.80 $24.00 $19.20 1,200 1,000 800 $14.00 $17.30 $21.00 157 158 159 160 181 162 163 184 185 Expected NPV- Standard Deviation Coefficient of Variation = Std Dev! Expected NPV = 166 d. If the project appears to be more or less risky than an average project, find its risk-adjusted NPV, IRR, and payback. 187 168 CV range of firm's average risk project: 0.8 to 1.2 169 Low-risk WACC = 8% 170 WACC - 10% 171 High-risk WACC - 13% 172 173 Risk-adjusted WACC = 174 Risk adjusted NPV - 175 IRR - 176 Payback 178 . On the basis of information in the problem, would you recommend that the project be accepted? 179 Build a Model + + Select destination and press ENTER or choose Past E- + 100%