You have just been hired by International 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 fiscal year 2014. 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 fiscal year 2014. 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 IBM's financial statements. (If you really worked for IBM you would already have this data, but at least

you won't 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.

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 project's profitability will be similar to IBM's existing projects in 2014 and estimate

(revenues - costs) each year by using the 2014 EBITDA/Sales profit margin. Calculate EBITDA as EBIT +

Depreciation expense from the cash flow statement.

Determine the annual depreciation by assuming IBM depreciates these assets by the straight-line method

over a 5-year life.

Determine IBM's tax rate by using the income tax rate in 2014.

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 2014 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 project's

required NWCfor example, IBM's 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 Excel's IRR function.

Perform a sensitivity analysis by varying the project forecasts as follows:

Suppose first year sales will equal 2%-4% of IBM's revenues.

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

Suppose revenue growth is constant after the first year at a rate of 0%10%.

Would appreciate a step by step breakdown of this on excel as well as the correlated functions that were used