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. Development of the new system will initially require an initial capital expenditure equal to 10% of IBMs Property, Plant, and Equipment (PPE) at the end of the latest fiscal year for which data is available. The project will then require an additional investment equal to 10% of the initial investment after the first year of the project, 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 IBMs total revenue for the latest fiscal year for which data is available. 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. Since your boss hasnt been much help (welcome to the real world!), here are some tips to guide your analysis: Obtain IBMs financial statements. (If you really worked for IBM 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 IBMs ticker symbol and then go to financials. 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:

Assume that the projects profitability will be similar to IBMs existing projects in the latest fiscal year and estimate ( revenues costs ) (revenuescosts) each year by using the latest EBITDA/Sales profit margin. Calculate EBITDA as EBIT + D e p r e c i a t i o n EBIT+Depreciation expense from the cash flow statement.

Income Statement Revenue Total Revenue Cost of Revenue - Gross Profit 12/31/2018 79,591,000 42,655,000 36,936,000 12/31/2017 79,139,000 42,196,000 36,943,000 12/31/2016 79,919,000 41,402,000 38,517,000 12/31/2015 81,741,000 41,057,000 40,684,000 5,379,000 20,325,000 5,590,000 20,900,000 5,247,000 5,726,000 20,225,000 19,589,000 Operating Expenses Research Development . Selling General and Administrative Non Recurring 1 Others 2 Total Operating Expenses 3 Operating Income or Loss -998,000 67,361,000 12,230,000 -1,445,000 67,241,000 11,898,000 -1,604,000 65,749,000 14,170,000 -669,000 65,224,000 16,517,000 5 Income from Continuing Operations 5 Total Other Income/Expenses Net 7 Earnings Before Interest and Taxes Interest Expense Income Before Tax Income Tax Expense 1 Minority Interest 2 Net Income From Continuing Ops -888,000 12,230,000 -723,000 11,342,000 2,619,000 134,000 8,723,000 -498,000 11,898,000 -615,000 11,400,000 5,642,000 131,000 5,758,000 -1,840,000 14,170,000 -630,000 12,330,000 449,000 146,000 11,881,000 -572,000 16,517,000 -468,000 15,945,000 2,581,000 162,000 13,364,000 5 Income from Continuing Operations 6 Total Other Income/Expenses Net 7 Earnings Before Interest and Taxes 8 Interest Expense 9 Income Before Tax Co Income Tax Expense -1 Minority Interest -2 Net Income From Continuing Ops -888,000 12,230,000 -723,000 11,342,000 2,619,000 134,000 8,723,000 -498,000 11,898,000 -615,000 11,400,000 5,642,000 131,000 5,758,000 -1,840,000 14,170,000 -630,000 12,330,000 449,000 146,000 11,881,000 -572,000 16,517,000 -468,000 15,945,000 2,581,000 162,000 13,364,000 5,000 -5,000 -9,000 -174,000 -4 Non-recurring Events -5 Discontinued Operations 26 Extraordinary Items -7 Effect of Accounting Changes -8 Other Items 8,728,000 5,753,000 11,872,000 13,190,000 0 Net Income =1 Net Income =2 Preferred Stock And Other Adjustments 3 Net Income Applicable To Common Shares 8,728,000 5,753,000 11,872,000 13,190,000 Income Statement Revenue Total Revenue Cost of Revenue - Gross Profit 12/31/2018 79,591,000 42,655,000 36,936,000 12/31/2017 79,139,000 42,196,000 36,943,000 12/31/2016 79,919,000 41,402,000 38,517,000 12/31/2015 81,741,000 41,057,000 40,684,000 5,379,000 20,325,000 5,590,000 20,900,000 5,247,000 5,726,000 20,225,000 19,589,000 Operating Expenses Research Development . Selling General and Administrative Non Recurring 1 Others 2 Total Operating Expenses 3 Operating Income or Loss -998,000 67,361,000 12,230,000 -1,445,000 67,241,000 11,898,000 -1,604,000 65,749,000 14,170,000 -669,000 65,224,000 16,517,000 5 Income from Continuing Operations 5 Total Other Income/Expenses Net 7 Earnings Before Interest and Taxes Interest Expense Income Before Tax Income Tax Expense 1 Minority Interest 2 Net Income From Continuing Ops -888,000 12,230,000 -723,000 11,342,000 2,619,000 134,000 8,723,000 -498,000 11,898,000 -615,000 11,400,000 5,642,000 131,000 5,758,000 -1,840,000 14,170,000 -630,000 12,330,000 449,000 146,000 11,881,000 -572,000 16,517,000 -468,000 15,945,000 2,581,000 162,000 13,364,000 5 Income from Continuing Operations 6 Total Other Income/Expenses Net 7 Earnings Before Interest and Taxes 8 Interest Expense 9 Income Before Tax Co Income Tax Expense -1 Minority Interest -2 Net Income From Continuing Ops -888,000 12,230,000 -723,000 11,342,000 2,619,000 134,000 8,723,000 -498,000 11,898,000 -615,000 11,400,000 5,642,000 131,000 5,758,000 -1,840,000 14,170,000 -630,000 12,330,000 449,000 146,000 11,881,000 -572,000 16,517,000 -468,000 15,945,000 2,581,000 162,000 13,364,000 5,000 -5,000 -9,000 -174,000 -4 Non-recurring Events -5 Discontinued Operations 26 Extraordinary Items -7 Effect of Accounting Changes -8 Other Items 8,728,000 5,753,000 11,872,000 13,190,000 0 Net Income =1 Net Income =2 Preferred Stock And Other Adjustments 3 Net Income Applicable To Common Shares 8,728,000 5,753,000 11,872,000 13,190,000