Capital Budgeting FuncoLand has developed a powerful new server that would be us

Question

Capital Budgeting
FuncoLand has developed a powerful new server that would be used for corporations’ Internet activities. 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 10% of the year’s projected sales; for example, NWC0 = 10% (Sales1). The servers would sell for $22,000 per unit, and Web- masters believes that variable costs would amount to $17,000 per unit. After Year 1, the sales price and variable costs will increase at the inflation rate of 2%. The company’s nonvariable costs would be $1,000,000 at Year 1 and would increase each year by the inflation rate. 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 (see page 543). The estimated market value of the equipment at the end of the project’s 4-year life is $500,000. FuncoLand’s federal-plus-state tax rate is 42%. Its cost of capital is 10%.
Part 1: Cash Flow Estimation
A) Calculate the net operating working capital for each year. (10 Points)
B) Calculate the net cash flow due to salvage. (10 Points)
C) Calculate net cash flows for each year. (10 Points)
Part 2: Capital Budgeting Analysis
D) Calculate the NPV, IRR, MIRR, Payback and Discounted Payback. (10 Points)

Input Data $10,000,000 10% 1000 $22,000 $17,000 1,000,000 500,000 Equipment cost Net operating working capital/Sales 0 First year sales (in units) 1 Sales price per unit first year 2 Variable cost per unit first year (excl. depr.) 3 Nonvariable costs first year (excl. depr.) 4 Market value of equipment at Year 4 5 Tax rate 6 WACC 7 Inflation in prices and costs 1096 2% 1 Part 1: Cash Flow Estimation 4 A) NOWC 6 Year 7 Units sold 8 Sales price per unit (excl. depr.) 9 Variable costs per unit (excl. depr.) 0 Nonvariable costs (excl. depr.) 1 Variable costs 2 Sales revenue 3 Net Operating Working Capital 6 B) Salvage 8 Year 9 Basis for depreciation 0 Annual equipment depreciation rate 1Annual depreciation expense 2 Ending Book Value: Depr. Expense Accum. Depr 3 Salvage value 4 Profit (or loss) on salvage 5 Tax on profit (or loss) 6 Net cash flow due to salvage 4

Explanation / Answer

Net Working Capital

Salvage Value

Cashflow

Part - B

NPV =961669

Payback Period =3 Years

Discounted Payback Period =3 Years and 6 Month

Payback

Discounted Payback Period

Particulars 1 2 3 4 Unit Sold 1000 1000 1000 100 Selling Price 22000 22440 22889 23347 Variable cost 17000 17340 17687 18041 Non Variable cost 1000000 1020000 1040400 1061208 Variable cost 17000000 17340000 17687000 18041000 Sales 22000000 22440000 22889000 23347000 Net Operating Working Capita 2200000 2244000 2288900 2334700

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