1. Sway's Back Store is considering a 7-year project which will require the purchase of $2 million in new
equipment. The equipment will be depreciated using MACRS method. Sway's Back Store will sell the equipment at the end of the project for a salvage value of $300,000. Annual sales from this project are estimated at $1,050,000 in year 1, and it is expected to grow by 3% each year. The variable cost is 40% of the annual sales and there is an annual fixed cost of $100,000. The store should build an inventory with a value of 10% of next year's sales. All of the new net working capital will be recouped at the end of the project. The firm desires a minimal 12% rate of return on this project. The tax rate is 40%.
a) Construct a capital budgeting table and calculate the Free Cash Flow of each year. Hint: you need to find out capital expenditure (1 points) , Salvage Cash Flow (3 points), Change in Net working Capital (3 points), Operating Cash Flows (8 points), and then Free Cash Flow (1 point)
b) Calculate the project NPV (3 points), IRR (2 points), Discounted Payback Period (4 points), Modified IRR (3 points)
c) Conduct a sensitivity analysis of NPV to the % change of 1st year sales. Hint: You will simulate at least 3 values for 1styear sales and record the corresponding NPV for each of the simulated sales value (6 points). Analysis the sensitivity and interpret the result (4 points)