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##### FIN - Case (11-18) - Build a Model: Issues in Capital Budgeting

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Question;(11-18);Build a Model: Issues in Capital Budgeting;Start with the partial model in the file Ch11 P18 Build a;Model.xls on the textbook?s Web site. Webmasters.com has developed a powerful;new server that would be used for corporations? Internet activities. It would;cost $10 million at Year 0 to buy the equipment necessary to manufacture the;server. The project would require net working capital at the beginning of a;year in an amount equal to 10% of the year?s projected sales;NOWC0 = 10%(Sales1). The servers would sell for $24,000 per;unit, and Webmasters believes 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 million at;Year 1 and would increase with inflation. 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 1,000 units;per year.;The equipment would be depreciated over a 5-year period;using MACRS rates. 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%. Its cost of capital is 10% for average-risk projects, defined as;projects with an NPV coefficient of variation between 0.8 and 1.2.;Low-risk projects are evaluated with aWACC of 8% and;high-risk projects at 13%.;a. Develop a spreadsheet model, and use it to find the;project?s NPV, IRR, and payback.;b. Now conduct a sensitivity analysis to determine the;sensitivity of NPV to changes in the sales price, variable costs per unit, and;number of units sold. Set these variables?values at 10% and 20% 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% probability that best-case conditions, with each of the variables discussed;in part b being 20% better than its base-case value, will occur. There is a 25%;probability of worst-case conditions, with the variables 20% worse than base;and a 50% probability of base-case conditions.;d. If the project appears to be more or less risky than an;average project, find its riskadjustedNPV, IRR, and payback.;e. On the basis of information in the;problem, would you recommend that the project be;accepted?

Paper#49482 | Written in 18-Jul-2015

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