Question

Dell is considering offering a new light-weight design laptop that would automatically be backed up to a cloud service. If a customer purchases the new product, they will transfer all files from the customers old machine to the cloud and have it synced to the new light-weight design laptop. The syncing station is estimated to have an initial start-up cost $9 mil along with an additional operating cost of $300,000 a year during the time they are selling the new laptop. Dell does not anticipate that they will be able to recoup any of these expenses at the end of the project, nor will any of these expenses be depreciated over the project life. Dell anticipates that they will be able to sell these new light-weight laptops for 7 years before it will become obsolete. The projected selling price for each laptop is ($1,800 for year 1 and decrease by 10% each year). The estimated demand for the laptop is 15,000 units in year 1, and is projected to increase by 11% each year for the life of the project. Each laptop will cost $1,000 to make. The project will require $2,700,000 in annual operating costs, which will increase 3% each year. Dell conservatively estimates that this new product will result in a $600,000 a year drop in sales from their existing laptop line. However, Dell anticipates that 35% of purchases will result in the purchase of an upgraded cloud service that sells for a one-time flat fee of $100. Dell will have to purchase an additional machine to manufacture the new light-weight laptops which will cost $400,000, and be depreciated using a 10-year straight line to zero schedule. At the end of the 7th year, Dell anticipates that it will be able to sell the machine for $25,000. Dell anticipates that it will need to have 10% worth of the current year’s laptop sales set aside in inventory to help sell the product, and will initially set aside 1 million in year 0. In the 7th year, all inventory will be liquidated and recouped. Dell currently has a tax rate of 21% and believes that a 15% discount rate would be appropriate given the amount of risk associated with the project.

Use excel to complete the following questions: A. What are the FCF for this project (years 0 to 7)? B. What is the NPV and IRR of this project? Should Dell accept this project? C. Graph the NPV of this project. D. What is the accounting break-even and cash break-even for year 1 (ignore taxes)? E. Conduct a Breakeven Analysis of the following assumptions: Sales growth, tax rate, Net-working capital-to-Sales, and Selling price discount (10% decrease in selling price each year). Report the expected value, the critical value (break-even), and the percentage change. Which input is the project’s success most sensitive to?

Answer 1

L S Tax rate 15% Rech M N Discount rate 21% o P Q R Operating Expense Capital Expendinture 27,00,000 14,00,000 SUMPRODUCT X f = 19-02-02 А B D G Year Cash flow Present value Interest Exp sales in unit 0 9,000,000 15000 1 16650 2 18481.5 3 20514.47 4 22771.06 5 25275.87 6 28056.22 7 31142.4 H Selling pri Sales Value 1800 27000000 1620 26973000 1458 26946027 1312.2 26919081 1180.98 26892162 1062.882 26865270 956.5938 26838404 860.934426811566) CFC = Revenue - Operating expense-Capital expenditure = 19-02-02 23711566