The Proposal
The Research and Development Division of your company has just developed a latest gaming system called the Zed Box. The R&D Division give $800,000 for developing this product and the Marketing Division has given another $210,000 to assess the market demand. They think that the Zed Box system has superior graphics and speed, and will have great market appeal at a competitive price of $225. The Marketing Division estimates the following demand for the Zed Box:
Year Units
2012 15,500
2013 30,000
2014 30,000
2015 30,000
2016 5,000
After that time they think there would be no more sales of the product as newer products become accessible. The Zed Box is expected to cost $132 each to manufacture (variable cost). Additionally, fixed production costs are estimated at $1 million per year. The manufacturing equipment necessary to create the games costs $2,800,000 million to purchase and would be depreciated at a 30 percent CCA rate. The manufacturing equipment is expected to have salvage value equivalent to 15% of the initial cost. We would need to invest $350,000 in net working capital up front (primarily for inventory) and NWC will rise to 18% of sales. The NWC will be recovered at the end of the project. The required return is 10 percent, and the tax rate is expected to be 42 percent.
Requirements
1. Using an Excel spreadsheet:
• Find out the NPV and IRR of the Zed Box project using the pro forma financial statement technique 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 calculations).
• Set up the essential equations by referencing to the input variable cells. The spreadsheet should be formula driven; don’t put any numbers in equations, only cell references.
• Use Excel’s built-in functions wherever probable (e.g. PV and IRR functions).
• HINTS: Your answer, the NPV of the proposal, must be $41,384 using the base case variables as stated in the proposal above. Appendix 10B in the text shows an example of a similar spreadsheet problem.
2. Breakeven analysis (cash B/E point only)
Set up a formula in Excel (this formula is not built-in) to compute the cash breakeven point for the base case.
3. Sensitivity analysis
a. Identify all the variables used in the proposal that are estimates or are subject to change during the life of the project. Briefly explain why these variables might change.
b. Select 2 variables that you identified above on which to do sensitivity analysis:
• Change these 2 variables (one at a time) in small increments through a fairly broad range of values using your Excel spreadsheet, and show how sensitive the project is to changes in these two variables. Remember, the better your sensitivity analysis, the more information it will give you to interpret and develop your recommendation.
• Present your sensitivity analysis in two Excel tables that summarize the results of your sensitivity analysis (i.e. the NPV, IRR and Breakeven Analysis results at the different values for the input variables). You will need Copy/Paste Special/Value to paste the changed values into your tables. Otherwise the values in your tables will keep changing when you change the input variables.
4. Recommendation
Use the results you obtained in the NPV, IRR, breakeven and sensitivity analysis above to write a one page report on your findings and recommend whether or not we should precede with the project.