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Week 3 Solution

The document describes a proposed project by Webmasters.com to develop a powerful new server to sell to corporations. It would cost $10 million initially and have a 4-year life. They expect to sell 1,000 servers per year for $24,000 each, with variable costs of $17,500 per unit. The project is estimated to have a positive NPV of $3.5 million and an IRR of 21% based on projected cash flows over 4 years and a salvage value of $500,000 for the equipment.

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I190006 Taimoor Jan
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91 views

Week 3 Solution

The document describes a proposed project by Webmasters.com to develop a powerful new server to sell to corporations. It would cost $10 million initially and have a 4-year life. They expect to sell 1,000 servers per year for $24,000 each, with variable costs of $17,500 per unit. The project is estimated to have a positive NPV of $3.5 million and an IRR of 21% based on projected cash flows over 4 years and a salvage value of $500,000 for the equipment.

Uploaded by

I190006 Taimoor Jan
Copyright
© © All Rights Reserved
Available Formats
Download as XLSX, PDF, TXT or read online on Scribd
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Webmasters.com has developed a powerful new server that would be used for corporations’ Internet activities.

It would cost $10 millio


necessary to manufacture the server. The project would require net working capital at the beginning of each year in an amount equal to
example, NWC0 = 10%(Sales1). The servers would sell for $24,000 per unit, and Webmasters believes that variable costs would amount
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 a

The server project would have a life of 4 years. If the project is undertaken, it must be continued for the entire 4 years
expected to be highly correlated with returns on the firm's other assets. The firm believes it could sell 1,000 units per y

The equipment would be depreciated over a 5-year period, using MACRS rates. The estimated market value of the e
4-year life is $500,000. Webmasters’ federal-plus-state tax rate is 40%. Its cost of capital is 10% for average-risk pro
coefficient of variation of NPV between 0.8 and 1.2. Low-risk projects are evaluated with a WACC of 8%, and

Input data table

Cost of equipement 10,000,000


NWC 10% next year sales/projected sales
selling cost 24000 per unit
variable cost 17500 per unit
inflation rate 3% SP VC FC
fixed cost/non variable cost 1,000,000
life 4 years
units sold 1000 units
salvage value 500,000
tax rate 40%
WACC 10%

Calculations
0 1 2 3 4
units sold 1000 1000 1000 1000
selling price 24000 24720 25461.6 26225.448
total sales/revenue 24000000 24720000 25461600 26225448
Variable cost 17500 18025 18565.75 19122.7225
total varaible cost 17500000 18025000 18565750 19122722.5
fixed cost 1,000,000 1030000 1060900 1092727
working capital 2400000 2472000 2546160 2622544.8 0
Depreciaiton expense 2000000 3200000 1920000 1152000
Book value 8,000,000 4,800,000 2,880,000 1,728,000

EBIT 3,500,000 2,465,000 3,914,950 4,857,999


tax 1400000 986000 1565980 1943199.4
income after tax 2,100,000 1,479,000 2,348,970 2,914,799

Add back non cash expenses 4,100,000 4,679,000 4,268,970 4,066,799

Terminal value 991,200


Change in net working capital -72000 -74160 -76384.8 2622544.8

0 1 2 3 4
Net cash flows 12,400,000 4,028,000 4,604,840 4,192,585 7,680,544
-12,400,000 4,028,000 4,604,840 4,192,585 7,680,544

Net present value 15,863,337.22 present value of inflows - initial outlay

3,463,337.22

IRR 21%

payback
0 1 2 3 4
cashflows -12,400,000 4,028,000 4,604,840 4,192,585 7,680,544

Cumulative cashflows -12,400,000 -8,372,000 -3,767,160 425,425

no of years before positve cash flow + (remaining cashflow/next year cashflow)


2.89852914616977
week 3 cash flow estimaitons

activities. It would cost $10 million at Year 0 to buy the equipment


of each year in an amount equal to 10% of the year's projected sales; for
that variable costs would amount to $17,500 per unit. After Year 1, the
sts would be $1 million at Year 1 and would increase with inflation.

continued for the entire 4 years. Also, the project's returns are
s it could sell 1,000 units per year.

stimated market value of the equipment at the end of the project’s


ital is 10% for average-risk projects, defined as projects with a
uated with a WACC of 8%, and high-risk projects at 13%.

MACRS
1 2 3 4
20% 32% 19.20% 11.52%

Amount * (1+g)

Income
Subtract: Expense
VC
FC
Dep exp
EBIT
Initial outlay Cost of asset + investment in WC at the start
tax
8272000 Acc Dep
1,728,000 cost - acc dep

Terminal value calculation


Salvage value 500,000
Book value 1,728,000
Profit/Loss -1,228,000

tax sheild -491200

Terminal cash flow 991,200


week 3 cash flow estimaitons

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