Question
You have just been hired by Dell Computers in their capital budgeting division. Your first assignment is to determine the net cash flows and NPV
You have just been hired by Dell Computers in their capital budgeting division. Your first assignment is to determine the net cash flows and NPV of a proposed new type of portable computer system similar in size to a BlackBerry, a popular gadget with many MBA students, which has the operating power of a high-end desktop system.
Development of the new system will initially require an initial investment equal to 10% of netProperty, Plant, and Equipment (PPE) for the fiscal year ended January 30, 2009. The project willthen require an additional investment equal to 10% of initial investment after the first year of theproject, a 5% increase after the second year, and a 1% increase after the third, fourth, and fifth years.The product is expected to have a life of five years. First-year revenues for the new product are expected to be 3% of total revenue for Dells fiscal year ended January 30, 2009. The new products revenues are expected to grow at 15% for the second year then 10% for the third and 5% annually for the final two years of the expected life of the project. Your job is to determine the rest of the cash flows associated with this project. Your boss has indicated that the operating costs and net working capital requirements are similar to the rest of the company and that depreciation is straight-line for capital budgeting purposes. Welcome to the real world. Since your boss hasnt been much help, here are some tips to guide your analysis:
- Obtain Dells financial statements. (If youreallyworked for Dell you would already have this data, but at least you wont 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 Dells ticker symbol and then go to financials.
- You are now ready to determine the Free Cash Flow. Compute the Free Cash Flow for each year using Eq. 8.5:
Free Cash Flow = (Revenues - Costs - Depreciation) x (1 - c) + 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.- Assume that the projects profitability will be similar to Dells existing projects in 2012 and estimate (revenues costs) each year by using the 2012 EBITDA/Sales profit margin. Calculate EBITDA as EBIT + Depreciation expense from the cash flow statement.
- Determine the annual depreciation by assuming Dell depreciates these assets by the straight-line method over a 10-year life.
- Determine Dells tax rate by using the income tax rate in 2012.
- 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 Dells 2012 NWC/Sales 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, Dells cash holdings.)
- To determine the free cash flow, calculate the additional capital investment and the change in net working capital each year.
- Use Excel to determine the NPV of the project with a 12% cost of capital. Also calculate the IRR of the project using Excels IRR function.
- Perform a sensitivity analysis by varying the project forecasts as follows:
- Suppose first year sales will equal 2%4% of Dells revenues.
- Suppose the cost of capital is 10%15%.
- Suppose revenue growth is constant after the first year at a rate of 0%10%.
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