Webmasters’ federal-plus-state tax rate is 25%. Its cost of capital is 10% for average-risk projects, defined as projects with a coefficient of variation of NPV between 0.8 and 1.2. Low-risk projects are evaluated with a WACC of 8%, and high-risk projects at 13%. 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 servers would sell for $24,000 per unit, and Webmasters believes that variable costs would amount to $18,000 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 also would increase at the 3% 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. 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 25%. Its cost of capital is 10% for average-risk projects, defined as projects with a coefficient of variation of NPV between 0.8 and 1.2. Low-risk projects are evaluated with a WACC of 8%, and high-risk projects at 13%. Also, the project's returns are expected to be highly correlated with returns on the firm's other assets.
a. Develop a spreadsheet model, and use it to find the project’s NPV, IRR, and payback.
Input Data (in thousands of dollars) Scenario name Base Case Note: the items in red will be used in a scenario analysis. Probability of scenario 50% Equipment cost $10,000 Net operating working capital/Sales 10% Key Results: First year sales (in units) 1,000 NPV = Sales price per unit $24.00 IRR = Variable cost per unit (excl. depr.) $18.00 Payback = Nonvariable costs (excl. depr.) $1,000 Inflation in prices and costs 3.0% Estimated salvage value at year 4 $500 Depreciation years Year 1 Year 2 Year 3 Year 4 Depreciation rates 20.00% 32.00% 19.20% 11.52% Tax rate 25% WACC for average-risk projects 10%