fcf_ch10_excel_master_student (1).xlsx
TRANSCRIPT
by Brad Jordan and Joe SmoliraVersion 10.0
Chapter 10In these spreadsheets, you will learn how to use the following Excel functions:
The following conventions are used in these spreadsheets:
1) Given data in blue2) Calculations in red
NOTE: Some functions used in these spreadsheets may require that the "Analysis ToolPak" or "Solver Add-In" be installed in Excel.To install these, click on the File tabthen "Excel Options," "Add-Ins" and select"Go." Check "Analysis ToolPak" and "Solver Add-In," then click "OK."
Ross, Westerfield, Jordan, and Roberts' Spreadsheet MasterFundamentals of Corporate Finance, 8th Canadian edition
Naming cells
SLN
VDB
Solver
In these spreadsheets, you will learn how to use the following Excel functions:
The following conventions are used in these spreadsheets:
NOTE: Some functions used in these spreadsheets may require that the "Analysis ToolPak" or "Solver Add-In" be installed in Excel.
Ross, Westerfield, Jordan, and Roberts' Spreadsheet MasterFundamentals of Corporate Finance, 8th Canadian edition
Chapter 10 - Section 3Pro Forma Financial Statements and Cash Flows
Cans sold per year: 50,000 Price per can: $ 4.00 Variable cost per can: $ 2.50 Required return: 20%Fixed costs per year: $ 12,000 Manufacturing equipment: $ 90,000 Project life (years): 3 Initial net working capital: $ 20,000 Tax rate: 34%
RWJ Excel Tip
With these numbers, we can prepare the pro forma income statement, which will be:
Sales $ 200,000 Variable costs 125,000 Fixed costs 12,000 Depreciation 30,000 EBIT $ 33,000 Taxes (34%) 11,220 Net income $ 21,780
RWJ Excel Tip
Because capital budgeting requires numerous repetitive cash flows, it is an ideal application for Excel. When doing a capital budgeting problem, as in most Excel uses, you should do few or no calculations on your own, but rather let Excel do the calculations for you. We will begin with the shark attractant project. We have the following projections for the project:
In a problem with a number of different variables, it can be advantageous to name the cells. Click on the input cell for the number of cans sold per year, and look to the left of the Formula bar in the name bar and you will see the name "Units." We entered the name in the name bar to name the input in this cell. Whenever we want to use the input from this cell later, we can type in the name of the variable instead of referencing the cell. For example, if you look at the sales calculation below, you will see that the formula we used in this cell is Units * Price_per_unit. When naming cells, you should keep the names short but understandable. In addition, Excel does not allow spaces in the variable name, so we used an underscore instead of the space in Price_per_unit.
To calculate the depreciation each year for straight-line depreciation, we can divide the initial cost by the life of the equipment, or we can use the built-in Excel function SLN as we have done here. The SLN we used in this case looks like this:
To calculate the AAR, we need the average investment in assets each year. The total investment each year will be:
Year0 1
Net working capital $ 20,000 $ 20,000 Net fixed assets 90,000 60,000 Total investment $ 110,000 $ 80,000
So, the average assets are:
Average assets: $ 65,000
Now, we can calculate the operating cash flow each year, which will be:
EBIT $ 33,000 + Depreciation 30,000 - Taxes 11,220 Operating cash flow $ 51,780
So, the total cash flow for each year of the project will be:
Year0 1
Operating cash flow $ 51,780 Changes in NWC $ (20,000)Capital spending (90,000)Total project cash flow $ (110,000) $ 51,780
Given these cash flows, we can now calculate the NPV, IRR, and AAR of the project, which are:
The inputs are Cost, which is the initial cost, Salvage, which is the salvage value, and Life, which is the life of the asset. In general, we usually find it easier just to divide the cost by the life of the equipment in the cell rather than use this particular function, but it is available if you prefer.
NPV $ 10,647.69 IRR 25.76%AAR 33.51%
Pro Forma Financial Statements and Cash Flows
With these numbers, we can prepare the pro forma income statement, which will be:
Because capital budgeting requires numerous repetitive cash flows, it is an ideal application for Excel. When doing a capital budgeting problem, as in most Excel uses, you should do few or no calculations on your own, but rather let Excel do the calculations for you. We will begin with the shark attractant project. We have the following projections
In a problem with a number of different variables, it can be advantageous to name the cells. Click on the input cell for the number of cans sold per year, and look to the left of the Formula bar in the name bar and you will see the name "Units." We entered the name in the name bar to name the input in this cell. Whenever we want to use the input from this cell later, we can type in the name of the variable instead of referencing the cell. For example, if you look at the sales calculation below, you will see that the formula we used in this cell is Units * Price_per_unit. When naming cells, you should keep the names short but understandable. In addition, Excel does not allow spaces in the variable name, so we used an underscore instead of the space in Price_per_unit.
To calculate the depreciation each year for straight-line depreciation, we can divide the initial cost by the life of the equipment, or we can use the built-in Excel function SLN as
To calculate the AAR, we need the average investment in assets each year. The total investment each year will be:
Year2 3
$ 20,000 $ 20,000 30,000 - $ 50,000 $ 20,000
Year2 3
$ 51,780 $ 51,780 $ 20,000
$ 51,780 $ 71,780
Given these cash flows, we can now calculate the NPV, IRR, and AAR of the project, which are:
The inputs are Cost, which is the initial cost, Salvage, which is the salvage value, and Life, which is the life of the asset. In general, we usually find it easier just to divide the cost by the life of the equipment in the cell rather than use this particular function, but it is available if you prefer.
Because capital budgeting requires numerous repetitive cash flows, it is an ideal application for Excel. When doing a capital budgeting problem, as in most Excel uses, you should do few or no calculations on your own, but rather let Excel do the calculations for you. We will begin with the shark attractant project. We have the following projections
In a problem with a number of different variables, it can be advantageous to name the cells. Click on the input cell for the number of cans sold per year, and look to the left of the Formula bar in the name bar and you will see the name "Units." We entered the name in the name bar to name the input in this cell. Whenever we want to use the input from this cell later, we can type in the name of the variable instead of referencing the cell. For example, if you look at the sales calculation below, you will see that the formula we used in this cell is Units * Price_per_unit. When naming cells, you should keep the names short but understandable. In addition, Excel does not allow spaces in the variable
To calculate the depreciation each year for straight-line depreciation, we can divide the initial cost by the life of the equipment, or we can use the built-in Excel function SLN as
The inputs are Cost, which is the initial cost, Salvage, which is the salvage value, and Life, which is the life of the asset. In general, we usually find it easier just to divide the
Chapter 10 - Section 4More on Project Cash Flow
In practice, most assets are depreciated on a MACRS schedule for tax purposes. The three-, five-, and seven-year MACRS schedules are:
Property ClassYear 3-year 5- year 7-year
1 33.33% 20.00% 14.29%2 44.45% 32.00% 24.49%3 14.81% 19.20% 17.49%4 7.41% 11.52% 12.49%5 11.52% 8.93%6 5.76% 8.92%7 8.93%8 4.46%
For example, suppose we have an asset that falls in the five-year MACRS classification and the initial cost is:
Initial cost: $ 12,000
The depreciation for each year will be:
Year Depreciation1 20.00% $ 2,400.00 2 32.00% 3,840.00 3 19.20% 2,304.00 4 11.52% 1,382.40 5 11.52% 1,382.40 6 5.76% 691.20
100.00% $ 12,000.00
To find the book value of the asset, we subtract depreciation each year from the beginning book value. The book value of this asset each year will be:
Year Depreciation1 $ 12,000 $ 2,400.00 $ 9,600.00 2 9,600.00 3,840.00 5,760.00 3 5,760.00 2,304.00 3,456.00 4 3,456.00 1,382.40 2,073.60
MACRS percentage
Beginningbook value
Endingbook value
5 2,073.60 1,382.40 691.20 6 691.20 691.20 -
Pretax salvage value: $ 3,000 Tax rate: 34%
The aftertax salvage value, and therefore net cash flow from selling the asset at the end of the project (Year 6 in this case) will be:
Pretax salvage value: $ 3,000.00 Taxes on sale: (1,020.00)Aftertax salvage value: $ 1,980.00
The Majestic Mulch and Compost Company (MMCC)
Year 1 2 3Units sales 3,000 5,000 6,000 Price $ 120 $ 120 $ 120 NWC to start $ 20,000 NWC % of sales 15%Variable cost $ 60 Fixed costs $ 25,000 Equipment $ 800,000 MACRS 14.29% 24.49% 17.49%Pretax salvage 20%Tax rate 34%Required return 15%
We will calculate the operating cash flow first, which we can calculate as net income plus depreciation. So, the pro forma income statements eachyear will be:
Pro Forma Income StatementsYear 1 2 3Revenues $ 360,000.00 $ 600,000.00 $ 720,000.00 Variable costs 180,000.00 300,000.00 360,000.00 Fixed costs 25,000.00 25,000.00 25,000.00 Depreciation 114,320.00 195,920.00 139,920.00 EBIT $ 40,680.00 $ 79,080.00 $ 195,080.00
When the asset is sold, taxes will be paid if the asset is sold for more than book value, or a tax rebate will be given if the asset is sold for less than book value. An easy way to calculate the taxes on the sale of the asset is (Book value - Market value)(Tax rate). Suppose the pretax salvage value of the asset and the tax rate are:
The MMCC capital budgeting problem is a more in-depth analysis. As before, we want to put all inputs in a separate cell and have Excel handle all the calculations. While we are entering the data in rows for each variable, we could enter the data in columns as well. The input information for the MMCC line of power mulching tools is:
Taxes (34%) 13,831.20 26,887.20 66,327.20 Net income $ 26,848.80 $ 52,192.80 $ 128,752.80 + Depreciation 114,320.00 195,920.00 139,920.00 OCF $ 141,168.80 $ 248,112.80 $ 268,672.80
RWJ Excel Tip
Year 0 1 2Initial NWC $ (20,000) $ 20,000.00 $ 54,000.00 Ending NWC 54,000.00 90,000.00 NWC cash flow $ (20,000) $ (34,000.00) $ (36,000.00)
To find the aftertax salvage value, we need to calculate the taxes. We get:
Pretax salvage value: $ 160,000.00 Taxes on sale: (54,400.00)Aftertax salvage value: $ 105,600.00
So, the total cash flows for each year of the project are:
Project Cash Flows Year 0 1 2OCF $ 141,168.80 $ 248,112.80 Change in NWC $ (20,000) (34,000.00) (36,000.00)Capital spending $ (800,000)Total cash flow $ (820,000) $ 107,168.80 $ 212,112.80
Finally, the NPV and IRR of the project are:
NPV: $ 65,487.70 IRR: 17.24%
A Note on MACRS Depreciation
Notice that in the income statements, we were careful to use absolute references in the variable costs, fixed costs, depreciation, and tax cells. That way, once we entered all the equations to calculate the net income during the first year, we simple copied and pasted the year 1 net income column to the rest of the years.
Next, we will calculate the change in net working capital. One way to do this is to calculate the difference between the beginning and ending net working capital. We also need to remember that the net working capital at the end of the project will be zero. So, the net working capital requirements each year are:
Equipment Life (Years)Year 3 5
1 33.33% 20.00%2 44.44% 32.00%3 14.81% 19.20%4 7.41% 11.52%5 11.52%6 5.76%789101112131415161718192021
RWJ Excel Tip
There are actually six MACRS schedules, three-, five-, seven-, 10-, 15-, and 20-year schedules. The MACRS schedule is calculated using the depreciation according to the double declining balance method, and switching to straight-line depreciation when it is more advantageous. The three-, five-, seven-, and 10-year schedules use a factor of 2 (200%) when calculating the double declining balance depreciation amount, while the 15- and 20-year schedules use a factor of 1.5 (150%). Excel has a function, VDB, which can be used to construct a MACRS table. Below, we have constructed a MACRS table with all six schedules.
To construct the MACRS table, we used the variable declining balance (VDB) function. Constructing the MACRS table is tricky because of the half-year convention. Below you will see what we entered for the second year of the three-year MACRS schedule.
Cost is the cost of the equipment. In this case, we entered one in order to get the answers as a percentage rather than a dollar amount. Salvage is the salvage value, which is zero. Life is the life of the asset. Since we have a table here, we entered the column as a floating input and locked the row. This allows us to copy and paste the formula further down the table was well as across. The Start_period is the starting period for which we want to calculate the depreciation. With the half-year convention, we used the year and subtracted 1/2. To calculate the End_period, we used the MIN function. This function will return the lesser of the next year minus one-half, or the life of the asset. In most years we could have taken the next year minus one-half, but this would not work for the last year. Notice that this MIN function will not work for the first year since there is no prior year. So, for the first year, we eliminated the MIN function. Finally, the Factor is not shown on the picture above since Excel scrolls through the inputs in this case. We used a factor of two for the three-, five-, seven-, and 10-year schedules and a factor of 1.5 for the 15- and 20-year schedules.
Finally, note that the MACRS schedule is slightly different from the table presented in the textbook for the 6th and 8th year of the seven-year MACRS schedule. The reason is that the IRS publishes a MACRS schedule, which is the schedule we used in the textbook. However, you are allowed to calculate the schedule on your own based on the rules outlined by the IRS. If you do so, you will get the table above, not the table in the textbook (or the table published by the IRS!). In the future, we will use the table in the textbook for our calculations.
In practice, most assets are depreciated on a MACRS schedule for tax purposes. The three-, five-, and seven-year MACRS schedules are:
For example, suppose we have an asset that falls in the five-year MACRS classification and the initial cost is:
To find the book value of the asset, we subtract depreciation each year from the beginning book value. The book value of this asset each year will be:
The aftertax salvage value, and therefore net cash flow from selling the asset at the end of the project (Year 6 in this case) will be:
4 5 6 7 6,500 6,000 5,000 4,000 $ 110 $ 110 $ 110 $ 110
12.49% 8.93% 8.93% 8.93%
We will calculate the operating cash flow first, which we can calculate as net income plus depreciation. So, the pro forma income statements each
Pro Forma Income Statements4 5 6 7
$ 715,000.00 $ 660,000.00 $ 550,000.00 $ 440,000.00 390,000.00 360,000.00 300,000.00 240,000.00 25,000.00 25,000.00 25,000.00 25,000.00 99,920.00 71,440.00 71,440.00 71,440.00 $ 200,080.00 $ 203,560.00 $ 153,560.00 $ 103,560.00
When the asset is sold, taxes will be paid if the asset is sold for more than book value, or a tax rebate will be given if the asset is sold for less than book value. An easy way to calculate the taxes on the sale of the asset is (Book value - Market value)(Tax rate). Suppose the pretax salvage value of the asset and the tax rate are:
The MMCC capital budgeting problem is a more in-depth analysis. As before, we want to put all inputs in a separate cell and have Excel handle all the calculations. While we are entering the data in rows for each variable, we could enter the data in columns as well. The input information for the MMCC line of power mulching tools is:
68,027.20 69,210.40 52,210.40 35,210.40 $ 132,052.80 $ 134,349.60 $ 101,349.60 $ 68,349.60 99,920.00 71,440.00 71,440.00 71,440.00 $ 231,972.80 $ 205,789.60 $ 172,789.60 $ 139,789.60
3 4 5 6 $ 90,000.00 $ 108,000.00 $ 107,250.00 $ 99,000.00 108,000.00 107,250.00 99,000.00 82,500.00 $ (18,000.00) $ 750.00 $ 8,250.00 $ 16,500.00
Project Cash Flows 3 4 5 6
$ 268,672.80 $ 231,972.80 $ 205,789.60 $ 172,789.60 (18,000.00) 750.00 8,250.00 16,500.00
$ 250,672.80 $ 232,722.80 $ 214,039.60 $ 189,289.60
Notice that in the income statements, we were careful to use absolute references in the variable costs, fixed costs, depreciation, and tax cells. That way, once we entered all the equations to calculate the net income during the first year, we simple copied and pasted the year 1 net income column to the rest of the years.
Next, we will calculate the change in net working capital. One way to do this is to calculate the difference between the beginning and ending net working capital. We also need to remember that the net working capital at the end of the project will be zero. So, the net working capital requirements each year are:
Equipment Life (Years)7 10 15 20
14.29% 10.00% 5.00% 3.75%24.49% 18.00% 9.50% 7.22%17.49% 14.40% 8.55% 6.68%12.49% 11.52% 7.70% 6.18%
8.92% 9.22% 6.93% 5.71%8.92% 7.37% 6.23% 5.28%8.92% 6.55% 5.90% 4.89%4.46% 6.55% 5.90% 4.52%
6.55% 6.02% 4.46%6.55% 6.02% 4.46%3.28% 6.02% 4.46%
6.02% 4.54%6.02% 4.54%6.02% 4.54%6.02% 4.54%3.01% 4.54%
4.54%4.54%4.54%4.54%2.27%
There are actually six MACRS schedules, three-, five-, seven-, 10-, 15-, and 20-year schedules. The MACRS schedule is calculated using the depreciation according to the double declining balance method, and switching to straight-line depreciation when it is more advantageous. The three-, five-, seven-, and 10-year schedules use a factor of 2 (200%) when calculating the double declining balance depreciation amount, while the 15- and 20-year schedules use a factor of 1.5 (150%). Excel has a function, VDB, which can be used to construct a MACRS table. Below, we have constructed a MACRS table with all six schedules.
To construct the MACRS table, we used the variable declining balance (VDB) function. Constructing the MACRS table is tricky because of the half-year convention. Below you will see what we entered for the second year of the three-year MACRS schedule.
Cost is the cost of the equipment. In this case, we entered one in order to get the answers as a percentage rather than a dollar amount. Salvage is the salvage value, which is zero. Life is the life of the asset. Since we have a table here, we entered the column as a floating input and locked the row. This allows us to copy and paste the formula further down the table was well as across. The Start_period is the starting period for which we want to calculate the depreciation. With the half-year convention, we used the year and subtracted 1/2. To calculate the End_period, we used the MIN function. This function will return the lesser of the next year minus one-half, or the life of the asset. In most years we could have taken the next year minus one-half, but this would not work for the last year. Notice that this MIN function will not work for the first year since there is no prior year. So, for the first year, we eliminated the MIN function. Finally, the Factor is not shown on the picture above since Excel scrolls through the inputs in this case. We used a factor of two for the three-, five-, seven-, and 10-year schedules and a factor of 1.5 for the 15- and 20-year schedules.
Finally, note that the MACRS schedule is slightly different from the table presented in the textbook for the 6th and 8th year of the seven-year MACRS schedule. The reason is that the IRS publishes a MACRS schedule, which is the schedule we used in the textbook. However, you are allowed to calculate the schedule on your own based on the rules outlined by the IRS. If you do so, you will get the table above, not the table in the textbook (or the table published by the IRS!). In the future, we will use the table in the textbook for our
In practice, most assets are depreciated on a MACRS schedule for tax purposes. The three-, five-, and seven-year MACRS schedules are:
To find the book value of the asset, we subtract depreciation each year from the beginning book value. The book value of this asset each year will be:
8 3,000 $ 110
4.45%
We will calculate the operating cash flow first, which we can calculate as net income plus depreciation. So, the pro forma income statements each
Pro Forma Income Statements8
$ 330,000.00 180,000.00 25,000.00 35,600.00 $ 89,400.00
When the asset is sold, taxes will be paid if the asset is sold for more than book value, or a tax rebate will be given if the asset is sold for less than book value. An easy way to calculate the taxes on the sale of the asset is (Book value - Market value)(Tax rate). Suppose the pretax salvage value of the asset and the tax rate are:
The MMCC capital budgeting problem is a more in-depth analysis. As before, we want to put all inputs in a separate cell and have Excel handle all the calculations. While we are entering the data in rows for each variable, we could enter the data in columns as well. The input information for the MMCC line of power mulching tools is:
30,396.00 $ 59,004.00 35,600.00 $ 94,604.00
7 8 $ 82,500.00 $ 66,000.00 66,000.00 - $ 16,500.00 $ 66,000.00
Project Cash Flows 7 8
$ 139,789.60 $ 94,604.00 16,500.00 66,000.00
105,600.00 $ 156,289.60 $ 266,204.00
Notice that in the income statements, we were careful to use absolute references in the variable costs, fixed costs, depreciation, and tax cells. That way, once we entered all the equations to calculate the net income during the first year, we simple copied and pasted the year 1 net income column to the rest of the years.
Next, we will calculate the change in net working capital. One way to do this is to calculate the difference between the beginning and ending net working capital. We also need
There are actually six MACRS schedules, three-, five-, seven-, 10-, 15-, and 20-year schedules. The MACRS schedule is calculated using the depreciation according to the double declining balance method, and switching to straight-line depreciation when it is more advantageous. The three-, five-, seven-, and 10-year schedules use a factor of 2 (200%) when calculating the double declining balance depreciation amount, while the 15- and 20-year schedules use a factor of 1.5 (150%). Excel has a function, VDB, which can be
To construct the MACRS table, we used the variable declining balance (VDB) function. Constructing the MACRS table is tricky because of the half-year convention. Below you will
Cost is the cost of the equipment. In this case, we entered one in order to get the answers as a percentage rather than a dollar amount. Salvage is the salvage value, which is zero. Life is the life of the asset. Since we have a table here, we entered the column as a floating input and locked the row. This allows us to copy and paste the formula further down the table was well as across. The Start_period is the starting period for which we want to calculate the depreciation. With the half-year convention, we used the year and subtracted 1/2. To calculate the End_period, we used the MIN function. This function will return the lesser of the next year minus one-half, or the life of the asset. In most years we could have taken the next year minus one-half, but this would not work for the last year. Notice that this MIN function will not work for the first year since there is no prior year. So, for the first year, we eliminated the MIN function. Finally, the Factor is not shown on the picture above since Excel scrolls through the inputs in this case. We used a
Finally, note that the MACRS schedule is slightly different from the table presented in the textbook for the 6th and 8th year of the seven-year MACRS schedule. The reason is that the IRS publishes a MACRS schedule, which is the schedule we used in the textbook. However, you are allowed to calculate the schedule on your own based on the rules outlined by the IRS. If you do so, you will get the table above, not the table in the textbook (or the table published by the IRS!). In the future, we will use the table in the textbook for our
Chapter 10 - Section 7Some Special Cases of Discounted Cash Flow Analysis
Setting a Bid Price
Equipment $ 3,300,000 Pretax salvage value $ 75,000 Units per year 125,000 Price per unit $ 22.64 VC as a percentage of sales 45%Fixed costs $ 425,000 MACRS Year 1 33.33%MACRS Year 2 44.44%MACRS Year 3 14.82%MACRS Year 4 7.41%Immediate NWC $ 80,000 Tax rate 35%Required return 10%
Pro Forma Income StatementsYear 1 2 3Revenues $ 2,829,542 $ 2,829,542 $ 2,829,542 Variable costs 1,273,294 1,273,294 1,273,294 Fixed costs 425,000 425,000 425,000 Depreciation 1,099,890 1,466,520 489,060 EBIT $ 31,358 $ (335,272) $ 642,188 Taxes (35%) 10,975 (117,345) 224,766 Net income $ 20,383 $ (217,927) $ 417,422 + Depreciation 1,099,890 1,466,520 489,060 OCF $ 1,120,273 $ 1,248,593 $ 906,482
To find the aftertax salvage value, we need to calculate the taxes. We get:
Pretax salvage value: $ 75,000.00 Taxes on sale: (26,250.00)Aftertax salvage value: $ 48,750.00
In the chapter, when we explained the process for setting a bid price, we assumed that the depreciation was straight-line. This assumption means that the math required to solve the NPV function is much simpler. With MACRS depreciation, even if sales are the same every year, the cash flows will be different each year. However, with Excel, we can solve for just about any variable. Suppose we are bidding on the following project. The contract will last for four years, and the equipment will be depreciated on a three-year MACRS schedule. What is the minimum bid price we could submit?
We entered a price in the appropriate cell above. As we will show later, it does not really matter what price we entered. Next, we need to calculate the cash flows and NPV for the project with our hypothetical price. This will be:
The total cash flows for each year of the project are:
Project Cash FlowsYear 0 1 2OCF $ 1,120,273 $ 1,248,593 Change in NWC $ (80,000)Capital spending $ (3,300,000)Total cash flow $ (3,380,000) $ 1,120,273 $ 1,248,593
Finally, the NPV of the project at this unit price is:
NPV: $ (0.00)
The minimum bid price is the price at which the NPV of the project is zero. We can use Solver to find this unit price (and much more.)
RWJ Excel TipTo use Solver, go to the Data tab, then click Solver. The inputs we used for this problem are:
Minimum bid price: $ 22.64
We restored the original unit price so you could use Solver on this problem for practice.
1) Go to the Office button on the top left, click Excel options, choose Add-Ins, select Excel Add-Ins in the pulldown menu near the bottom of the box, and click on Go.2) Uncheck the Solver add-in and click OK.
4) Check the Solver add-in and select OK.
Example 10.4: Equivalent Annual Cost
Equipment $ 1,100,000 $ 1,900,000 Operating cost $ 60,000 $ 10,000 Life (years) 5 8
Discount rate 12%Tax rate 34%
We can calculate the NPV of each project as:
Income Statements
Operating cost $ 60,000 $ 10,000 Depreciation 220,000 237,500 EBIT $ (280,000) $ (247,500)Tax (95,200) (84,150)Net income $ (184,800) $ (163,350)
As you see, with Solver you first enter the target cell you would like to set to a specific value, in this case, the NPV cell. Since the lowest bid price is the price that results in a zero NPV, we chose to set the NPV cell equal to a value of zero. Next, we select the cell we would like to change in order to set the target cell equal to the value we chose. In this case, we changed the unit price cell. This is why the original value we entered for the unit price is irrelevant: Solver will change the value when it solves the problem. Note that after we used Solver, we restored the original value. On the next worksheet, you can see the answer report generated by Solver. In this case, the bid price that results in a zero NPV is:
NOTE: There is a bug in Solver that will occur occasionally. In some cases, Solver will not launch, or if you try to save one or more of the reports, you may see "Solver: An unexpected internal error or available memory was exhausted" pop up. In this case, the solution is to uninstall Solver and re-install it. To do this:
3) Go to the Office button on the top left, click Excel options, choose Add-Ins, select Excel Add-Ins in the pulldown menu near the bottom of the box, and click on Go. This is a repeat of Step 1.
To find the equivalent annual cost (EAC,) we find the net present value of the project, then find the annuity that represents the annual cost based on the life of the project. We have two different options for a pollution control system, a filtration system or a precipitation system. The relevant numbers for each alternative are:
Filtrationsystem
Precipitationsystem
Filtrationsystem
Precipitationsystem
So, using the bottom-up approach, the OCF for each alternative is:
OCF $ 35,200 $ 74,150
Now, we can calculate the NPV of each project:
NPV $ (973,112) $ (1,531,650)
Using the PMT function to find the EAC, we get:
EAC ($269,950.71) ($308,325.40)
In the final analysis, we should choose the system that is the least expensive, which is the filtration system.
Some Special Cases of Discounted Cash Flow Analysis
Pro Forma Income Statements4
$ 2,829,542 1,273,294 425,000 244,530 $ 886,718 310,351 $ 576,367 244,530 $ 820,897
To find the aftertax salvage value, we need to calculate the taxes. We get:
In the chapter, when we explained the process for setting a bid price, we assumed that the depreciation was straight-line. This assumption means that the math required to solve the NPV function is much simpler. With MACRS depreciation, even if sales are the same every year, the cash flows will be different each year. However, with Excel, we can solve for just about any variable. Suppose we are bidding on the following project. The contract will last for four years, and the equipment will be depreciated on a three-year MACRS
We entered a price in the appropriate cell above. As we will show later, it does not really matter what price we entered. Next, we need to calculate the cash flows and NPV for the
The total cash flows for each year of the project are:
Project Cash Flows3 4
$ 906,482 $ 820,897 80,000 48,750
$ 906,482 $ 949,647
Finally, the NPV of the project at this unit price is:
The minimum bid price is the price at which the NPV of the project is zero. We can use Solver to find this unit price (and much more.)
To use Solver, go to the Data tab, then click Solver. The inputs we used for this problem are:
We restored the original unit price so you could use Solver on this problem for practice.
1) Go to the Office button on the top left, click Excel options, choose Add-Ins, select Excel Add-Ins in the pulldown menu near the bottom of the box, and click on Go.
As you see, with Solver you first enter the target cell you would like to set to a specific value, in this case, the NPV cell. Since the lowest bid price is the price that results in a zero NPV, we chose to set the NPV cell equal to a value of zero. Next, we select the cell we would like to change in order to set the target cell equal to the value we chose. In this case, we changed the unit price cell. This is why the original value we entered for the unit price is irrelevant: Solver will change the value when it solves the problem. Note that after we used Solver, we restored the original value. On the next worksheet, you can see the answer report generated by Solver. In this case, the bid price that results in a zero NPV is:
There is a bug in Solver that will occur occasionally. In some cases, Solver will not launch, or if you try to save one or more of the reports, you may see "Solver: An unexpected internal error or available memory was exhausted" pop up. In this case, the solution is to uninstall Solver and re-install it. To do this:
3) Go to the Office button on the top left, click Excel options, choose Add-Ins, select Excel Add-Ins in the pulldown menu near the bottom of the box, and click on Go. This is
To find the equivalent annual cost (EAC,) we find the net present value of the project, then find the annuity that represents the annual cost based on the life of the project. We have two different options for a pollution control system, a filtration system or a precipitation system. The relevant numbers for each alternative are:
In the final analysis, we should choose the system that is the least expensive, which is the filtration system.
To find the aftertax salvage value, we need to calculate the taxes. We get:
In the chapter, when we explained the process for setting a bid price, we assumed that the depreciation was straight-line. This assumption means that the math required to solve the NPV function is much simpler. With MACRS depreciation, even if sales are the same every year, the cash flows will be different each year. However, with Excel, we can solve for just about any variable. Suppose we are bidding on the following project. The contract will last for four years, and the equipment will be depreciated on a three-year MACRS
We entered a price in the appropriate cell above. As we will show later, it does not really matter what price we entered. Next, we need to calculate the cash flows and NPV for the
The total cash flows for each year of the project are:
Finally, the NPV of the project at this unit price is:
The minimum bid price is the price at which the NPV of the project is zero. We can use Solver to find this unit price (and much more.)
To use Solver, go to the Data tab, then click Solver. The inputs we used for this problem are:
1) Go to the Office button on the top left, click Excel options, choose Add-Ins, select Excel Add-Ins in the pulldown menu near the bottom of the box, and click on Go.
As you see, with Solver you first enter the target cell you would like to set to a specific value, in this case, the NPV cell. Since the lowest bid price is the price that results in a zero NPV, we chose to set the NPV cell equal to a value of zero. Next, we select the cell we would like to change in order to set the target cell equal to the value we chose. In this case, we changed the unit price cell. This is why the original value we entered for the unit price is irrelevant: Solver will change the value when it solves the problem. Note that after we used Solver, we restored the original value. On the next worksheet, you can see the answer report generated by Solver. In this case, the bid price that results in a zero NPV is:
There is a bug in Solver that will occur occasionally. In some cases, Solver will not launch, or if you try to save one or more of the reports, you may see "Solver: An unexpected internal error or available memory was exhausted" pop up. In this case, the solution is to uninstall Solver and re-install it. To do this:
3) Go to the Office button on the top left, click Excel options, choose Add-Ins, select Excel Add-Ins in the pulldown menu near the bottom of the box, and click on Go. This is
To find the equivalent annual cost (EAC,) we find the net present value of the project, then find the annuity that represents the annual cost based on the life of the project. We have two different options for a pollution control system, a filtration system or a precipitation system. The relevant numbers for each alternative are:
In the final analysis, we should choose the system that is the least expensive, which is the filtration system.
Microsoft Excel 12.0 Answer ReportWorksheet: [Chapter 10.xlsx]Section 10.6Report Created: 02/19/2012 5:35:12 PM
Target Cell (Value Of)Cell Name Original Value Final Value
$C$55 NPV: Project Cash Flows $ - ###
Adjustable CellsCell Name Original Value Final Value
$D$11 Price per unit $ 22.64 ###
ConstraintsNONE
Chapter 10 - Master it!
a. What is the profitability index of the project?
b. What is the IRR of the project?
c. What is the NPV of the project?
d. At what price would Conch Republic Electronics be indifferent to accepting the project?
e. At what level of variable costs per unit would Conch Republic Electronics be indifferent to accepting the project?
For this Master It! assignment, refer to the Conch Republic Electronics case at the end of Chapter 10. For your convenience, we have entered the relevant values in the case such as the price, variable cost, etc. on the next page. For this project, answer the following questions:
At what price would Conch Republic Electronics be indifferent to accepting the project?
At what level of variable costs per unit would Conch Republic Electronics be indifferent to accepting the project?
For this Master It! assignment, refer to the Conch Republic Electronics case at the end of Chapter 10. For your convenience, we have entered the relevant values in the case such as the price, variable cost, etc. on the next page. For this project, answer the following questions:
For this Master It! assignment, refer to the Conch Republic Electronics case at the end of Chapter 10. For your convenience, we have entered the relevant values in the
Master it! Solution
Equipment $ 21,500,000 Pretax salvage value $ 4,100,000 R&D $ 750,000 Marketing study $ 200,000
Year 1 Year 2Sales (units) 74,000 95,000 Sales of old PDA 80,000 60,000 Lost sales 15,000 15,000 Depreciation rate 14.29% 24.49%
Price $ 360 VC $ 155 FC $ 4,700,000 Price of old PDA $ 290 Price reduction of old PDA $ 35 VC of old PDA $ 120 Tax rate 35%NWC percentage 20%Required return 12%
Sales Year 1 Year 2NewLost salesLost revenueNet sales
VCNewLost salesTotal VC
SalesVCFixed costsDepEBTTaxNI+Dep
OCF
NWCBegEndNWC CF
Net CF
SalvageBV of equipmentTaxes
Salvage CF
Time Cash flow012345
a. Profitability index
b. IRR
c. NPV
d. Minimum price
e. Maximum VC
Year 3 Year 4 Year 5 125,000 105,000 80,000
17.49% 12.49% 8.93%
Year 3 Year 4 Year 5