Instructions: Return this cover sheet with the final answers and attach complete solutions for each problem and highlight in yellow your final answer at the end of each solution. You will get partial credit. You will lose a lot of points if you do not attach complete solutions! Make sure to submit complete and readable tables. Just providing the correct final number would not give you a full score!
Late submissions carry a 10% penalty if submitted within 24 hours of the deadline and a 20% penalty if submitted within 48 hours of the deadline. I will grade generously so using the late submission option is usually not advisable. Your maximum score is 100 points. I will give the maximum points for each question if your answers are correct, complete, and clearly presented.
Short Answers (please also provide spreadsheets and longer explanations and complete pro-forma analysis tables in separate file):
- Net Cash Flow in Year 0:
Net Cash Flow in Year 1:
Net Cash Flow in Year 2:
Net Cash Flow in Year 3:
Net Cash Flow in Year 4:
Start project (Yes/No):
- Bid price (in $) that makes financial sense:
Bid price that adds $2 million to the value of the company:
Questions are based on the following mini-case: CGX Transmitters is developing a 2nd generation optical transmitter. Somebody in your department worked on it and prepared a pro-forma analysis but then he left the firm last week. You suspect that he was fired because of a very bad analysis.
The CEO needs the capital budget on his desk Wednesday morning because he senses that one of our major customers might be interested in an exclusive contract. She knows that you are taking FIN305W and that you can complete and correct the budget that the finance group started and she asks the CFO to assign you. You collect the following information:
- The project will last for four years.
- The initial investment in equipment is $25 million. The firm will use a straight-line depreciation schedule in years one to four, with the book value of the equipment going down from $25 million in year zero down to a book value of $5 million in year four. (A colleague reminds you to not forget to use any remaining book value to reduce taxes on a potential re-sale at the end. He believes that the previous guy got canned for mistakes like this!)
- The firm estimates that they will be able to sell the equipment (and license the technology) to another firm for $10 million in year four. This number does not include any potential taxes on this transaction.
- The firm spent $12.5 million on R&D last year in order to research the technology behind the 2nd generation transmitter.
- If you undertake this project, operating income before tax of the 1st generation optical transmitter will decline by an annual amount of $1.2 million for each of the next four years.
- The accounting department will assign a $1 million administration costs per year for years one to four. You check with them, and they give you the following breakdown: $175,000 a year for accounting services to produce paperwork necessary to run the project and comply with federal and state regulations, and $825,000 towards the overall costs of maintaining the firm’s headquarters. Even though the headquarters will not be involved with running this project, they argue that the cost of the headquarters has to be spread over all existing projects.
- The tax rate is 21%. The cost of capital is 9.5%. Assume that the firm’s other projects yield a positive income before tax.
The transmitter is expected to sell for $11.50 with per unit variable cost of $3.70. The following sales information is compiled by the marketing department (in $ million) and net working capital by the accounting department:
Year Units Sold Net working capital
0 0 units $1.1 million
1 1.6 million units $2.7 million
2 2.4 million units $4.4 million
3 2.9 million units $2.5 million
4 0.8 million units $0
Hence, the sales in year one will be worth $18.40 million (1.6 million units * $11.50 sale price) and the COGS in year one will be $5.92 million (1.6 million units * $3.70 per unit cost). Similarly, you need to compute the dollar amount of sales and COGS in year two to year four.
Question 1 (60 points)
Take the completed pro-forma analysis and correct all mistakes.
Carefully read the case. Use the provided pro-forma analysis and correct all the mistakes your colleague made. For your answer, provide the completed pro-forma analysis with the project OCF, taxes, capital investment, side effects, and project net cash flow in year 0, 1, 2, 3, 4. Provide all columns and highlight in yellow your final net cash flow answers. The pro-forma analysis should be performed in the same spreadsheet, with well organized, complete, and readable explanations so that it can be passed by to the CFO’s desk tomorrow COB, and sent to the CEO shortly.
Question 2 (20 points)
What is the NPV of the project? What is the project’s IRR? Should the project be started?
Question 3 (20 points)
The firm was also approached by a military agency. They are proposing a government contract that will give the exclusive rights of the product to the military. They want to know at what price you can deliver the same quantities to the military and not sell any on the open market.
(A) The CEO asks for the contract bid-price (i.e. the price per unit) that will guarantee the project makes sense financially?
(B) The CEO also wants to know at what bid-price the project will bring in $2 million in present value to the company?