FINC 4352 – Intermediate Finance

Project 4

Capital Budgeting

The goal of this project is to explore the topic of capital budgeting. The project requires you to work in Excel with the provided spreadsheet. Be sure to fill in the yellow boxes in the Excel file for full credit. In addition, type up a 1-2 page report in Word with an introduction (description of the project), findings (answer assignment questions, plots, etc.), and conclusion (summary). Make sure to follow all directions or points will be deducted. This is an individual project so be sure to submit your own work. Upon completion, please submit both your Word report and Excel file to blackboard. Questions A, B, C, D, and E are worth 12 points each. The report is worth 15 points. If you employ external references, please cite them in a bibliography section.

Capital Budgeting

FuncoLand has developed an efficient, new cloud server that that it can sell to other corporations to boost online operations and stability. For FuncoLand, it would cost $10,000,000 at Year 0 to buy the equipment necessary to manufacture the server. The project would require net working capital at the beginning of each year in an amount equal to 11% of the next year’s projected sales; for example, NWC₀ = 11% (Sales₁). The servers would sell for $24,000 per unit, and specialists estimate that variable costs would amount to $17,500 per unit. After Year 1, the sales price and variable costs will increase at the inflation rate of 3%. The company’s nonvariable costs would be $1,000,000 (per 1,000 units) at Year 1 and would increase at the inflation rate each year thereafter. The server project would have a life of 4 years. 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 a constant 1,000 units per year. The equipment would be depreciated over a 4-year period, using MACRS rates as shown below:

The estimated market value of the equipment at the end of the project’s 4-year life is $2,000,000. FuncoLand’s federal-plus-state tax rate is 30%. Its cost of capital is 10%.

Part 1: Cash Flow Estimation

1. Calculate the sales revenues for each year. (12 Points)
   1. Note the units sold are constant each year
   1. The sales price, variable cost, and nonvariable cost increase each year by the inflation rate
   1. NOWC_t = (11%)(Sales_t+1)

• Calculate the net cash flow due to salvage. (12 Points)
  • Annual depreciation expense = (Basis for depreciation) (Annual depreciation rate)
  • Ending Book Value = Previous book value – Current annual depreciation expense
  • Profit (or loss) on salvage = Salvage value – Ending book value
  • Tax on profit (or loss) = Profit (or loss) on salvage * Tax rate
  • Net cash flow due to salvage = Salvage value – Tax on profit (or loss)

• Calculate net cash flows for each year. (12 Points)
  • EBIT = Sales revenues – Variable costs – Nonvariable costs – Depreciation
  • Cash flow due to change in NOWC_t = NOWC_t-1 – NOWC_t
  • Net cash flow = NOPAT + Depreciation + Equipment Purchase + Cash flow due to change in NOWC + Net cash flow due to salvage

Part 2: Capital Budgeting Analysis

• Calculate the NPV, IRR, MIRR (using Excel function, and the Payback and Discounted Payback using formulas (12 Points)
  • NPV Excel function see https://support.office.com/en-us/article/npv-function-8672cb67-2576-4d07-b67b-ac28acf2a568 for more information
  • IRR Excel function see https://support.office.com/en-us/article/irr-function-64925eaa-9988-495b-b290-3ad0c163c1bc for more information
  • MIRR Function see https://support.office.com/en-us/article/mirr-function-b020f038-7492-4fb4-93c1-35c345b53524 for more information

Part 3: Risk Analysis

• Use the Excel What-IF Analysis to conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price. Set the variables’ values at 25% and 50% above and below their base-case values. Include a graph in your analysis of the NPV on the y-axis and the percent deviation from base on the x-axis. Label the graph title and axes. (12 Points)

Hint: Select the Data tab, What-If Analysis, Scenario Manager. Add a scenario for each deviation. Select the Sales price cell in part A as the changing cell. Type in the value of the changing cell according to the deviation selected. Click on Summary. Select Scenario summary, highlight the NPV cell from part D in the result window, and click OK. The first row of the Result cells represents the new NPV value. For more information about Excel What if analysis: https://support.office.com/en-us/article/switch-between-various-sets-of-values-by-using-scenarios-2068afb1-ecdf-4956-9822-19ec479f55a2?ui=en-US&rs=en-US&ad=US