In this project, you are asked to analyze the NPV and IRR of a new product for Dell, one of the largest computer makers in the world. Your assignment is to determine the cash flows and NPV of a proposed new type of tablet computer similar to size to an iPad but with the operating power of a high-end desktop system. Let’s assume the new product is comparable to STREAK – the tablet computer Dell launched in the summer of 2010 to compete with iPad.
Development of the new system will initially require an initial capital expenditure equal to 10% of Dell’s Property, Plant, and Equipment (PPE) at the end of fiscal year 2012. 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 Dell’s total revenue for the fiscal year 2012. The new product’s 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 hasn’t been much help (welcome to the “real world”!), here are some tips to guide your analysis;
1. Obtain Dell’s financial statements. Download the annual income statements, balance sheets, and cash flow statements for the last four fiscal years from Yahoo! Finance (finance.yahoo.com). Enter Dell’s ticker symbol and then go to “financials.”
2. You are now ready to estimate the Cash Flow for the new product. Set up the timeline and computation of cash flow in separate, contiguous columns for each year of the project life. Be sure to make outflows negative and inflows positive.
a. Assume that the project’s profitability will be similar to Dell’s 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.
b. Determine the annual depreciation by assuming Dell fully depreciates these assets by the straight-line method over a 10-year life.
c. Determine Dell’s tax rate by using the income tax rate in 2012.
d. 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 Dell’s 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 project’s required NWC – for example, Dell’s cash holdings.)
e. For capital budgeting purposes, assume that at the end of FY2017, Dell can dispose (sell) the PPE for this project at its remaining book value, and assume that Dell can dispose its net working capital at the end of FY2017. That is, NWC for FY2017 is 0.
f. To determine the cash flow, deduct the additional capital investment and the change in net working capital each year.
3. 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.
4. Perform a sensitivity analysis by varying the project forecasts as follows:
a. Suppose first year sales will equal 2%-4% of Dell’s revenues.
b. Suppose the cost of capital is 10%-15%.