Spreadsheet Assignment on Cash Flow Estimation

Webmasters.com has developed a powerful new server that would be used for corporations' Internet activities. It would cost $10 million to buy the equipment necessary to manufacture the server, and $3 million of net working capital would be required. The servers would sell for $24,000 per unit, and Webmasters believes that variable costs would amount to $17,500 per unit. The company's annual fixed costs would also rise by $1 million. The server project would have a life of 4 years. Conditions are expected to remain stable during each year of the operating life; that is, unit sales, sales price, and costs would be unchanged. If the project is undertaken, it must be continued for the entire 4 years. Also, the project's returns 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.

The equipment would be depreciated over a 5-year period, using the following annual MACRS rates: 20 percent, 32 percent, 19 percent, 12 percent, 11 percent, and 6 percent. The estimated market value of the equipment at the end of the project's 4-year life is $500,000. Webmasters' federal-plus-state tax rate is 40 percent. Its cost of capital is 10 percent for average-risk projects, defined as projects with a coefficient of variation of NPV between 0.8 and 1.2. Low-risk projects are evaluated with a WACC of 8 percent, and high-risk projects are evaluated at 13 percent.

a. Develop a spreadsheet model and use it to find the project's NPV and IRR.

b. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable cost per unit, and number of units sold. Set these variables' values at 10 per-cent and 20 percent above and below their base-case values. Include a graph in your analysis.

c. Now conduct a scenario analysis. Assume that there is a 25 percent probability that "best-case" conditions with each of the variables discussed in Part b being 20 percent better than its base-case value (i.e., higher sales price, lower variable cost per unit, and higher number of units sold), will occur. There is a 25 percent probability of "worst-case" conditions, with the variables 20 percent worse than base (i.e., lower sales price, higher variable cost per unit, and lower number of units sold), and a 50 percent probability of base-case conditions.

d. If the project appears to be more or less risky than an average project, find its risk-adjusted NPV and IRR.

e. On the basis of information in the problem, would you recommend that the project to be accepted?

f. Attach a digital copy of your spreadsheet to your report.