Copyright © 2023 Cengage Learning Canada, Inc.

Build-A-Model Solution
to accompany
Spreadsheet Problem 11-24

Webmasters.com has developed a powerful new server that would be used for corporations’ Internet activities. It would cost $10 mi
to buy the equipment necessary to manufacture the server. The project would require net working capital at the beginning of each y
10% of sales (NOWC0 = 10%(Sales1), NOWC1 = 10%(Sales2), etc.). The servers would sell for $24,000 per unit, and Webmasters bel
variable costs would amount to $17,500 per unit. After Year 1, the sales price and variable costs would increase at the inflation rate
company’s non-variable costs would be $1 million at Year 1, and would increase with inflation. The server project would have a life
the project is undertaken, it must be continued for the entire 4 years. Also, the project’s returns are expected to be highly correlated
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 a CCA rate of 35%. The estimated market value of the equipme
of the project’s 4-year life is $500,000. Webmasters’ tax rate is 40%. Its cost of capital is 10% for average risk projects, defined as p
coefficient of variation for NPV between 0.8 and 1.2. Low risk projects are evaluated with a WACC of 8%, and high risk projects at

a. Develop a spreadsheet model and use it to find the project’s NPV, IRR, and payback.

Key Output:
Part 1. Input Data (in thousands of dollars except for unit amount)

Equipment cost $ 10,000

Net Operating WC/sales 10% Market value of equipment at Year 4
Yearly sales (in units) 1,000 Tax rate
Sales price per unit $24.00 WACC
Variable cost per unit $17.50 Inflation
Non-variable costs $1,000 CCA rate

Part 2. CCA Schedule

Years Beg. UCC CCA End UCC
year 1 10,000 1,750 $8,250
year 2 8,250 2,888 $5,363
year 3 5,363 1,877 $3,486
year 4 3,486 1,220 $2,266 Here it's ass
the equipme
Part 3. Net Salvage Values, in Year 4 Equipment pool is close
Estimated Market Value in Year 4 $500 end of the p
Ending UCC in Year 4 2,266
Recaptured depreciation (+) or Terminal loss (-) -1,766
Taxes paid (+) or tax credit (-) -706
Net cash flow from salvage $1,206

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Part 4. Projected Net Cash Flows (Time line of annual cash flows)
Years 0 1 2
Investment Outlays at Time Zero:
Equipment $ (10,000)

Operating Cash Flows over the Project's Life:

Units sold 1,000 1,000
Sales price $19.20 $19.78
Variable costs $17.50 $18.03

Sales revenue $19,200 $19,776

Variable costs 17,500 18,025
Non-variable operating costs 1,000 1,030
Depreciation (equipment) 1,750 2,888
Oper. income before taxes (EBIT) (1,050) (2,167)
Taxes on operating income (40%) (420) (867)
Net Operating Profit After Taxes (NOPAT) (630) (1,300)
Add back depreciation 1,750 2,888
Operating cash flow $1,120 $1,588

Terminal Year Cash Flows:

Required level of net operating working capital $1,920 $1,978 $2,037
Required investment in NOWC ($1,920) ($58) ($59)

Terminal Year Cash Flows:

Net salvage value

Net Cash Flow (Time line of cash flows) ($11,920) $1,062 $1,528

Part 5. Key Output: Appraisal of the Proposed Project

Net Present Value (at 10%) -$5,935

IRR -11.96% Applies MIN function
MIRR -7.40% to Row 73 to find
first year when
payback is positive.
Payback (See calculation below) 4.00

Data for Payback Years 0 1 2

Net cash flow (11,920) 1,062 1,528
Cumulative CF (11,920) (10,858) (9,329)
Part of year required for payback: 1.00 1.00

b. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and nu
sold. Set these variables’ values at 10% and 20% above and below their base case values. Include a graph in your analysis.

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Evaluating Risk: Sensitivity Analysis

I. Sensitivity of NPV to Changes in Inputs. Here we use an Excel "Data Table" to find NPV different unit sales, holding other thi

% Deviation 1st YEAR UNIT SALES % Deviation WACC

from Units NPV from NPV
Base Case Sold -$5,935 Base Case WACC (5,935)
-20% 800 -$6,482 -20% 8.0% -$5,600
-10% 900 -$6,208 -10% 9.0% -$5,771
0% 1,000 -$5,935 0% 10.0% -$5,935
10% 1,100 -$5,661 10% 11.0% -$6,092
20% 1,200 -$5,387 20% 12.0% -$6,243

% Deviation VARIABLE COSTS % Deviation SALES PRICE

from Variable NPV from Sales NPV
Base Case Costs -$5,935 Base Case Price -$5,935
-20% $14.00 $1,003 -20% $19.20 -$5,935
Although i
-10% $15.75 -$2,466 -10% $21.60 -$5,935
not vary in
0% $17.50 -$5,935 0% $24.00 -$5,935 firm under
10% $19.25 -$9,404 10% $26.40 -$5,935 reorganiza
20% $21.00 -$12,872 20% $28.80 -$5,935

% Deviation NON-VARIABLE COSTS

from Fixed NPV
Base Case Costs -$5,935 Note about data tables. The data in the column input should NO
-20% $800 -$5,538 using a cell reference to the column input cell. For example the b
-10% $900 -$5,736 number of units sold in cell B105 should be the number 1000; you
have the formula =D29 in that cell. This is because you'll use D29
0% $1,000 -$5,935 column input cell in the data table and if Excel tries to iteratively
10% $1,100 -$6,133 D29 with the formula =D29 rather than a series of numbers, Exce
20% $1,200 -$6,331 calculate the wrong answer. Unfortunately, Excel won't tell you
problem, so you'll just get the wrong values for the data table!

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 number of units sold in cell B105 should be the number 1000; you
have the formula =D29 in that cell. This is because you'll use D29
column input cell in the data table and if Excel tries to iteratively
D29 with the formula =D29 rather than a series of numbers, Exce
calculate the wrong answer. Unfortunately, Excel won't tell you
problem, so you'll just get the wrong values for the data table!

Sensitivity Analysis

$11,000
$9,000
$7,000 Sales pric
$5,000 VC
NPV

$3,000 Units
$1,000 Non-var.
($1,000) WACC
($3,000)
($5,000)
($7,000)
-20% -10% 0% 10% 20%

Deviation NPV at Different Deviations from Base

from NPV Variable Non-variable
Base Case Cost Units Sold Cost WACC
-20% ($5,935) $1,003 (6,482) ($5,538) ($5,600)
-10% ($5,935) ($2,466) (6,208) ($5,736) ($5,771)
0% ($5,935) ($5,935) (5,935) ($5,935) ($5,935)
10% ($5,935) ($9,404) (5,661) ($6,133) ($6,092)
20% ($5,935) ($12,872) (5,387) ($6,331) ($6,243)

Range $ - $ 13,876 1,094 $ 793 $ 643

c. Now conduct a scenario analysis. Assume that there is a 25% probability that “best case” conditions, with each of the variables
Part b being 20% better than its base case value, will occur. There is a 25% probability of “worst case” conditions, with the variable
than base, and a 50% probability of base case conditions.

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Part 7. Evaluating Risk: Scenario Analysis

Sales Unit Variable

Scenario Probability Price/Unit Sales Costs/Unit NPV

Best Case 25% $28.80 1,200 $14.00 $27,262

Base Case 50% $24.00 1,000 $17.50 $4,216
Worst Case 25% $19.20 800 $21.00 ($12,002)

Expected NPV = sum, prob times NPV $5,923

Standard Deviation = Sq Root of column H sum $9,106
Coefficient of Variation = Std Dev / Expected NPV 1.54

IRR
d. If the project appears to be more or less risky than an average project, find its risk-adjusted NPV, IRR, and payback.

With the high coefficient of variation (2.36), we must re-evaluate the project using a higher WACC, 13%. That results in:
Pa
Risk adjusted NPV = $ 2,337
ch
IRR = -11.96%
Payback = 4.00

e. On the basis of information in the problem, would you recommend that the project be accepted?

At this point, the project looks risky but acceptable. There is a good chance that it will produce a positive NPV, but
there is also a chance that the NPV could be quite low.

The problem gave no information about the size of the project relative to the total corporation. If the company were quite
large, and this were but one of many projects, and if the projects were independent of one another, then it should be
accepted. However, if the firm were relatively small, and this project under bad conditions could bankrupt the company,
then the decision is not clear. If management is highly risk averse, they might turn it down. However, well-diversified
investors would probably prefer to see it accepted. So, to maximize the stock price, it should be accepted.

We indicate in the problem that this project's returns will tend to be highly correlated with the firm's other projects'
returns. Thus, its stand-alone risk (which is what we have been analyzing) also reflects its within-firm risk. If this
were not true, then we would need to make further risk adjustments.

Page 5
activities. It would cost $10 million at Year 0
pital at the beginning of each year equal to
per unit, and Webmasters believes that
d increase at the inflation rate of 3%. The
erver project would have a life of 4 years. If
xpected to be highly correlated with returns

ed market value of the equipment at the end

erage risk projects, defined as projects with a
f 8%, and high risk projects at 13%.

NPV = $ (5,935)
IRR = -11.96%
MIRR = -7.40%

uipment at Year 4 $500

40%
10%
3.0%
35.0%

Here it's assumed that

the equipment asset
pool is closed at the
end of the project.

Page 6
 3 4

1,000 1,000
$20.37 $20.98
$18.57 $19.12

$20,369 $20,980
18,566 19,123
1,061 1,093
1,877 1,220
(1,134) (455)
(454) (182)
(681) (273)
1,877 1,220
$1,196 $947

$2,098 $0
($61) $2,098

1,206

$1,135 $4,251

Applies MIN function

o Row 73 to find
irst year when
payback is positive.

3 4
1,135 4,251
(8,194) (3,943)
1.00 1.00

variable costs per unit, and number of units

graph in your analysis.

Page 7
ent unit sales, holding other thing constant.

Although in most cases, fixed cost might

not vary in a firm; it might happen if the
firm undertakes significant level of
reorganization/ restructuring

n the column input should NOT be input

n input cell. For example the base case
hould be the number 1000; you should NOT
. This is because you'll use D29 as the
and if Excel tries to iteratively replace cell
than a series of numbers, Excel will
rtunately, Excel won't tell you that there is a
ng values for the data table!

Page 8
hould be the number 1000; you should NOT
. This is because you'll use D29 as the
and if Excel tries to iteratively replace cell
than a series of numbers, Excel will
rtunately, Excel won't tell you that there is a
ng values for the data table!

Sales price
VC
Units
Non-var. cost
WACC

ns, with each of the variables discussed in

e” conditions, with the variables 20% worse
Some of these numbers may appear
too large, as we are using squared
values; This step in an intermediary
step to arrive at the 'standard
deviation' number

Page 9
 Some of these numbers may appear
too large, as we are using squared
values; This step in an intermediary
Squared step to arrive at the 'standard
Deviation deviation' number
Times
Probability The deviation (NPV of
the scenario minus
1,138,382 expected NPV ) squared
times the probability.
1,456,925
80,326,406

IRR does not change.

IRR, and payback.

3%. That results in:

Paypack does not
change.

itive NPV, but

company were quite

en it should be
krupt the company,
, well-diversified

other projects'
m risk. If this

Page 10
 1,000
$24.00
$17.50

Page 11
 1,200
$28.80
$14.00

Page 12
 800
$19.20
$21.00

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Copyright © 2023 Cengage Learning Canada, Inc.
Scenario Summary
Current Values: Base Best Worst
Changing Cells:
$D$29 1,000 1,000 1,200 800
$D$30 $24.00 $24.00 $28.80 $19.20
$D$31 $17.50 $17.50 $14.00 $21.00
Result Cells:
$D$79 $4,216 $4,216 $27,262 ($12,002)
$D$80 20.84% 20.84% 76.46% #NUM!
$D$81 16.20% 16.20% 42.44% -39.58%
Notes: Current Values column represents values of changing cells at
time Scenario Summary Report was created. Changing cells for each
scenario are highlighted in gray.