Suppose Amazon has decided to introduce the Echo III. Before they launch the Echo III, they conducted an analysis to see if the Echo II would be a desirable investment. The company estimated that it would sell 10 million Echo IIIs per year at a price of $250 for the next six years.
The initial capital outlay is determined to be $1.25 billion and a $600 million outlay in net working capital would also be required.
Assume that the equipment used will be depreciated using the MACRS 7 year schedule and that the equipment has a salvage value of zero. At the end of year 6, the equipment will be sold for its book value. Also, assume that that the tax rate is 25%.
1. Using information from Amazon’s financial statements (you may want to use Morningstar.com or some other online site) estimate the operating cash flows from the project. Make any simplifying assumptions that are necessary to produce the estimate.
2. If the cost of capital is 12%, compute the NPV and IRR for the project. Test the sensitivity of NPV to changes in the cost of capital by increasing the WACC by 1%.
3. Test the sensitivity of NPV and IRR to changes in the growth rate of sales. Use a -2% 0% and 2% growth rate for sales in your analysis. (use the original 12% cost of capital for this part of the assignment).
4. Test the sensitivity of NPV and IRR to changes in the cost of goods sold percentage. Use a percentage that is 2% less than the number you originally estimated to do the computation. Then recalculate using a percentage that is 3% more than you originally estimated. For example, if you used 80%, redo the calculations using 77% and 83%.
5. Use the 10 year Treasury Bond rate as the risk free rate and assume that the market risk premium is 7% to find Amazon’s cost of equity. Assume that Amazon’s bonds are rated AAA and that Amazon’s corporate tax rate is 25%. Find Amazon’s weighted average cost of capital. Assume that the project will be financed with internal funds. You will need to find additional financial information from the Wall Street Journal and online at sites like http://finance.yahoo.com to complete your calculation.
6. Using your cost of capital estimates in part 5, recalculate the original NPV and IRR using these new estimates. (Redo part 2, but use the number you estimated instead of 12%).
7. Write up your findings and determine if Amazon should produce the Echo III. You do not need to submit a spreadsheet for every calculation. Just summarize your results in a table and submit one spreadsheet. Given your analysis, should Amazon proceed with the Echo III?
Please show all work/ formulas in excel