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Amadeus Corporation is considering the issue of a new product to be added to its product mix. They hired you, a recent business graduate, for conducting the analysis. The production line would be set up in an unused space at the company’s main plant. The plant space could be leased out to another firm at $20,000 per year. They have to buy new machinery. The approximate cost of the machine would be $170,000, with another $15,000 in shipping and handling charges. It would also cost an additional $25,000 to install the equipment. The machinery has an economic life of 6 years and would be in Class 8 with a CCA rate of 35%. The machinery is expected to have a salvage value of $90,000 after 6 years of use.
The new product line would generate incremental sales of 1,400 units per year for 6 years and they are expected to grow 5% per year. The cost per unit is estimated in $55 per unit in the first year. Each unit can be sold for $200 in the first year. The sales price and cost per unit are both expected to increase by 3.2% per year due to inflation. The fixed costs are estimated to be $100,000 at the end of 1st year and would increase with inflation. To handle the new product line, the firm’s net operating working capital would be an amount equal to 15% of sales revenues. The firm tax rate is 37%. There are 1000 common shares outstanding with market price of $40 each. Also they have 100 preferred shares with market value of $50. There are $50,000 long-term bond trading in market with an average price of $1,100 and 6 years to maturity, and 8% semi-annual coupon. Common shares of firm have a beta of 1.3. Risk free rate is 4% and expected market return is 16%. Preferred stock holder are receiving 1 dollar quarterly dividend. The project is considered by the financial department to be as risky as the company. The reinvestment risk is assumed to be 15%.
1. Using an Excel spreadsheet
• Find the NPV, IRR and MIRR of the project by using the pro forma financial statement method to determine cash flows.
• Enter the input variables in cells of their own at the top of the spreadsheet (so it is easier to do sensitivity analysis calculations).
• Set up the necessary equations by referencing to the input variable cells. The spreadsheet must be formula driven; do not put any numbers in equations, only cell references.
• Use Excel’s built-in functions wherever possible (e.g. NPV and IRR functions).
2. Breakeven analysis
At what WACC rate and Unit Sales price the project is going to break-even based on NPV method.
3. Sensitivity analysis
Consider the following assumptions for the company and for each case individually calculate the NPV and include these analyses in your final recommendation.
Perform sensitivity analysis on the unit sales, variable costs and the cost of capital (WACC) for the project. Assume that each of these variables can vary from its base-case value by ±20%. Summarize the results in a table (NPVs and IRRs for each sensitivity analysis).
4. Scenario Analysis
Assume that you are confident of your estimates of all variables that affect the project’s cash flows except unit sales and sales price. If product acceptance is poor, unit sales will be only 900 units a year and the unit price will be only $150; a strong demand will produce sales of 1,700 units and a unit price of $240. The marketing department told you that there is a 25% chance of poor acceptance and 25% chance of strong acceptance, and a 50% chance of average acceptance (the base case).
(a) What are the worst case NPV and the best case NPV?
(b) What are the expected NPV and risk involved given the mentioned probabilities?
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Use the results you obtained in the NPV, IRR, breakeven, sensitivity and scenario analysis above to write a one page report on your findings and recommend whether or not the company should proceed with the project.
6. Present this assignment in a professional way. It is your responsibility to communicate clearly to the marker.
7. Submit: (FOLLOW THESE INSTRUCTIONS STRICTLY)
• Worksheet 1, cover page with your names (all members of group).
• Worksheet 2, Excel spreadsheet showing base case NPV, IRR and MIRR and breakeven values (Requirements 1 and 2)
• Worksheet 3, sensitivity analysis along with a table showing the NPV for each sensitivity analysis
• Worksheet 4, NPV for each scenario (worst & best case, and expected NPV and risk)
• Worksheet 5, Executive Summary of interpretation and recommendation (Requirement 5). Max. one page.
• You can complete this assignment in groups of up to 2 or 3 students
• Please list all group member’s names in the excel file you submit
• Please note that each group should submit only one Excel file
• Submissions should INCLUDE ALL NAMES OF GROUP MEMBERS BOTH in the email and in the file names**
• **Appropriate naming for each of the files to be submitted with 2 members named Bob and Fred would be:
Marking Max. Mark
1. Excel NPV, IRR, B/E and supporting formula sheet 25
2. Sensitivity analysis 5
3. Scenario analysis 10
4. Interpretation of results/recommendation 5
5. Presentation (spelling, grammar, organization) 5
|Sales per year in units||–|
|Fixed cost||$ –|
|VC per unit||$ –|
|Cost of Machine||$ –|
|Cost of Shipping and Installation||$ –|
|Salvage Value||$ –|
|NOWC as % of Sales||0%|
|Plant Space Rent||$ –|
|Sales Growth rate||0.0%|
|Cost of Equity||0.0%|
|Cost of Preferred stock||0.0%|
|Cost of Debt||0.0%|
|Weight of Equity||0.0%|
|Weight of Debt||0.0%|
|Weight of Preferred Stock||0.0%|
|Tax at 37%|
|Net income (NOPAT)|
|OCF (NI + Dep.)|
|Investment (changes) in NOWC|
|Net Salvage Value|
|Net Cash Flow|
|CCA – Machinery|
|Net Salvage Values, in Year 6||Machinery|
|Estimated Market Value in Year 5|
|Ending UCC in Year 5|
|Recaptured depreciation (+) or Terminal loss (-)|
|Taxes paid (+) or tax credit (-)|
|Net cash flow from salvage|
|WACC breakeven point in units|
|Unit Sales Price breakeven point in units|
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