# Problem#11

vamsee121

Pinto.com has developed a powerful new server that would be used for corporationsâ€™ Internet activities. It would cost \$25 million at Year 0 to buy the equipment necessary to manufacture the server. The project would require net working capital at the beginning of each year in an amount equal to 12% of the yearâ€™s projected sales; for example, NWC0 = 12%(Sales1 ). The servers would sell for \$21,000 per unit, and Pinto believes that variable costs would amount to \$15,000 per unit. After Year 1, the sales price and variable costs will increase at the inflation rate of 2.5%. The companyâ€™s nonvariable costs would be \$1.5 million at Year 1 and would increase with inflation. The server project would have a life of 4 years. If the project is undertaken, it must be continued for the entire 4 years. Also, the projectâ€™s returns are expected to be highly correlated with returns on the firmâ€™s other assets. The firm believes it could sell 2,000 units per year. 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 projectâ€™s 4-year life is \$1 million. Pinto.comâ€™s federal-plus-state tax rate is 20%. 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 an 8% project cost of capital and high-risk projects at 13%.

1. Develop a spreadsheet model, and use it to find the projectâ€™s NPV, IRR, and payback.
2. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the sales price, variable costs per unit, and number of units sold. Set these variablesâ€™ values at 10% and 20% above and below their base-case values.
3. Now conduct a scenario analysis. Assume that there is a 25% probability that best-case conditions, with each of the variables discussed in Part b being 20% better than its base-case value, will occur. There is a 25% probability of worst-case conditions, with the variables 20% worse than base, and a 50% probability of base-case conditions.
4. If the project appears to be more or less risky than an average project, find its risk-adjusted NPV, IRR, and payback.
5. On the basis of information in the problem, would you recommend the project should be accepted?
• a year ago
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