You have just been hired by Dell Computers in their capital budgeting division. Your first assignment IS to determine the free cash flows and NPV of a proposed new type of tablet computer similar in size to an iPad but with the operating power of a high-end desktop system.
Development of the new system will initially require an initial capital expenditure equal to 10% of Dell's Property, Plant, and Equipment (PIT) at the end of fiscal year 2012. The project will then require an additional investment equal to 10% of the initial investment after the first year of the project, a 5% increase after the second year, and a 1% increase after the third, fourth, and fifth yeas. The product is expected to have a life of five years. First-year revenues for the new product are expected to be 3% of Dell's total revenue for the fiscal year 2012.
The new product's revenues are expected to grow at 15% for the second year then 10% for the third and 5% annually for the final two years of the expected life of the project. Your job is to determine the rest of the cash flows a.ociated with this project. Your boss has indicated that the operating cosrs and net working capital requirements are similar to the test of the company and that depreciation is straight-fine for capital budgeting purposes. Since your boss hasn't been much help (welcome to the "real world"!), here are some tips to guide your analysis:
1. Obtain Dell's financial statements. (If you really worked for Dell you would already have this data, but at least you won't get used if your analysis is off target.) Download the annual income statements, balance sheets, and cash flow statements for the last four fiscal years from Yahoo! Finance (finance.yahoo.com). Enter Dell's ticker symbol and then go to "financials."
2. You are now ready to minute the Free Cash Flow for the new product. Compute she Fres Cash Flow for each year using Eq. 8.5:
Free Cash Flow = (Revenues - Costs - Depreciation) x (1 - Τc + Depreciation - CapEx - ΔNWC
Set up the timeline and computation of free rash flow in separate, contiguous columns for each year of the project life. Be sure to make outflows negative and inflows positive.
a. Assume that the projea's profitability will be similar to Dell's existing projects in 2012 and estimate (rove nuu - costs) each year by using the 2012 EBITDA/Sales profit margin. Calculate EBITDA as EBIT + Depreciation expense from rho cash flow statement.
b. Determine the annual depreciation by assuming Dell depreciates these assets by the straight-line method over a 5-year life.
c. Determine Dell's tax rate by using the income tax rate in 2012.
d. Calculate the net working capital required each year by assuming that the level of NWC will be a constant percentage of the project's sales. Use Dell's 2012 NWC/Sales to estimate the required percentage. (Use only accounts receivable, accounts payable, and inventory to measure working capital. Other components of current assets and liabilities are harder to interpret and not necessarily reflective of the project's required NWC-for example, Dell's cash holdings.)
e. To determine the Ern cash flow, deduct rho additional capital investment and the change in net working capital ad, year.
Use Excel to determine the NPV of the project with a 12% cost of capital. Also calculate the IRR of the project using Excelk IRE fimction.
Perform a sensitivity analysis by varying the project forecasts as follows:
a. Suppose first year sales will equal 2%-4% of Dell's revenues.
b. Suppose the cost of capital is 10%-15%.
c. Suppose revenue growth is constant after the first year at a rate of 0% - 10%.