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Apple Inc.: Capital Budgeting Analysis Apple Inc. (ticker: AAPL) is considering installing a new and highly sophisticated computer system in one of its manufacturing facilities, which would cost $71.0 million. Delivery and installation would add another $1.2 million to the initial cost. The new computer system has a 5-year class life under MACRS. Because of the half-year convention, it will take six years for Apple to fully depreciate the cost of the system (MACRS percentages: 20, 32, 19, 12, 11 and 6 percent), and at the end of year 6 the salvage value of the system is estimated to be S5.XXX million, where XXX are the digits found in your KU email address. Additional data: If the new system is purchased, revenue from greater sales is expected to increase over the present level by $105 million in each of the first three years, by S97 million in year 4, and by $88 million in years 5 and 6. (These improvements are incremental, not cumulative.) The increase in operating costs is projected at $68 million for each of the six years. Apples federal-plus-state income tax rate is 40 percent. The projects weighted average cost of capital (WACC) is 12.0 percent. It is expected that installation of the new system would cause the following changes in working capital accounts (1) an increase in receivables of $25 million because of expanded business, (2) an increase in inventories of S6 million, and (3) an increase in accounts payable and accruals combined equal to S5 million. Using Excel, do the following: a. State the basic assumptions o the problem in an assumption block. This means that you should display in the upper left-hand corner of the spreadsheets all the relevant quantitative information given above, whether it actually changes in the problem or not. Enter the numbers in thousands. For example, enter the $25 million increase in receivables as $25,000 in the spreadsheet. b. Calculate (1) the projects net cash outflow at time zero (t - 0) if Apple goes ahead with this expansion; (2) construct a table along the following lines to calculate the project net cash flows for years 1 through 6 (in thousands); and (3) calculate the NPV of the expansion project. (Note: The NPV function in Excel assumes the first cash flow is for period 1 not time 0. Thus, the initial time 0 cash outflow needs to be outside the NPV function, but still part of the calculation. Confirm the correct NPV by checking it with your calculator.)Year 媔 Additional revenue due to expansion Additional operating costs (excluding Depreciation (DEP) EBIT (or operating income) Taxes on operating income After-tax project operating income (OI) Operating cash flow (OI +DEP) Recovery of Working Capital Salvage after tax Project net cash flows (operating + non-operating) NPVThe real power of Excel spreadsheets is their ability to perform sensitivity analyses (answer what-if questions). It is therefore crucial that you set up your model such that the stated assumptions in Part (a) are the underlying determinants of the capital budgeting calculations performed in Part (b). A change in any one of the assumptions in Part (a) will then automatically cause a recalculation of the projects NPV. In other words, be sure to use formulas and refer to earlier cell addresses whenever appropriate. If your model is constructed correctly, the remaining questions should r equire very little time to answer Save all of your work in Parts (a) and (b) as AAPL-A and B (the tab name) Because computer hardware and software prices are notoriously difficult to estimate beyond a couple of years -let alone resale values the salvage value of the new system is somewhat iffy. However, the Forecasting Department guesses that the salvage value will not drop below $1.4 million. Using this worst-case scenario as far as salvage is concerned (i.e., a salvage value of S1.4 million), what is the new NPV? Other assumptions are as in Parts (a) and (b). Answer by duplicating the assumption block and NPV analysis to create a new spreadsheet. Save as AAPL-C. c. d. While analyzing the project, you suddenly realize that the current tax law actually allows Apple to depreciate the computer system over four years instead of six. Assume percentages of 33, 45, 15, and 7 percent, and assume that the system will, in fact, be used for six years as originally planned. All other assumptions are as in Part (c). Calculate a new NPV on a new spreadsheet, and save as AAPL-D Your boss would also like to know just how sensitive the NPV of the project is to operating costs. What is the highest annual operating cost increase associated with the project that would result in a positive NPV? (HINT: Find the answer using the Goal Seek function in Excel. Solve for the operating cost that sets NPV to S1). All other assumptions are as in Part d. Recalculate a new NPV on a new spreadsheet, and save as AAPL-E. (Hint: If your NPV cell is in units of thousands, an NPV of S1 would be shown as S0.001.) e. f. Change annual operating costs back to S68 million. Find the IRR of the project using Goal Seek. (HINT: Solve for the cost of capital that sets the NPV to zero). All other assumptions are as in Part (e), with operating costs back to S68 million. Save as AAPL-F the spreadsheet showing your IRR solution.

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Answer #1
AAPL- A& B
a. Basic assumptions:
Initial cost
Cost of manufacturing facility -71000
Delivery&Installation -1200
Total outlay -72200
MACRS rates
Year Rate %
1 20
2 32
3 19
4 12
5 11
6 6
100
Salvage 5000
After-tax salvage(5000*(1-40%)) 3000
Changes to working capital:
Increase in receivables -25000
Increase in inventories -6000
Increase in a/cs pay. & accruals 5000
Net change in w/c -26000
b. Project's net Time 0 Cash flows
Total initial outlay -72200
Net change in w/c -26000
Total time 0 cash flows -98200
Year 1 2 3 4 5 6
Addl.revenue due to expansion 105000 105000 105000 97000 88000 88000
Addl.operating costs(excl.depn.) -68000 -68000 -68000 -68000 -68000 -68000
Depreciation(DEP) -14440 -23104 -13718 -8664 -7942 -4332
EBIT(or opg.inc.) 22560 13896 23282 20336 12058 15668
Taxes on opg. Inc. -9024 -5558 -9313 -8134 -4823 -6267
After-tax project opg. Inc.(OI) 13536 8338 13969 12202 7235 9401
Opg. Cash flow(OI+DEP) 27976 31442 27687 20866 15177 13733
Recovery of W/c 98200
Salvage after-tax 3000
Project net cash flows
(opg.+non-opg.) -98200 27976 31442 27687 20866 15177 114933
NPV(Excel fn.) 51651.548
Verification of NPV as per Excel
PV F at 12% 1 0.892857 0.797194 0.71178 0.635518 0.567427 0.506631
PV at 12% -98200 24978.57 25065.05 19707.2 13260.47 8611.724 58228.53
NPV 51651.548
AAPL-C
a. Basic assumptions:
Initial cost
Cost of manufacturing facility -71000
Delivery&Installation -1200
Total outlay -72200
MACRS rates
Year Rate %
1 20
2 32
3 19
4 12
5 11
6 6
100
Salvage 1400
After-tax salvage(1400*(1-40%)) 840
Changes to working capital:
Increase in receivables -25000
Increase in inventories -6000
Increase in a/cs payables & accruals 5000
Net change in w/c -26000
b. Project's net Time 0 Cash flows
Total initial outlay -72200
Net change in w/c -26000
Total time 0 cash flows -98200
Year 1 2 3 4 5 6
Addl.revenue due to expansion 105000 105000 105000 97000 88000 88000
Addl.operating costs(excl.depn.) -68000 -68000 -68000 -68000 -68000 -68000
Depreciation(DEP) -14440 -23104 -13718 -8664 -7942 -4332
EBIT(or opg.inc.) 22560 13896 23282 20336 12058 15668
Taxes on opg. Inc. -9024 -5558 -9313 -8134 -4823 -6267
After-tax project opg. Inc.(OI) 13536 8338 13969 12202 7235 9401
Opg. Cash flow(OI+DEP) 27976 31442 27687 20866 15177 13733
Recovery of W/c 98200
Salvage after-tax 840
Project net cash flows
(opg.+non-opg.) -98200 27976 31442 27687 20866 15177 112773
NPV(Excel fn.) 50557.225
Verification of NPV as per Excel
PV F at 12% 1 0.892857 0.797194 0.71178 0.635518 0.567427 0.506631
PV at 12% -98200 24978.57 25065.05 19707.2 13260.47 8611.724 57134.21
NPV 50557.225
AAPL-D
a. Basic assumptions:
Initial cost
Cost of manufacturing facility -71000
Delivery&Installation -1200
Total outlay -72200
MACRS rates
Year Rate %
1 33
2 45
3 15
4 7
5 0
6 0
100
Salvage 1400
After-tax salvage(1400*(1-40%)) 840
Changes to working capital:
Increase in receivables -25000
Increase in inventories -6000
Increase in a/cs payables & accruals 5000
Net change in w/c -26000
b. Project's net Time 0 Cash flows
Total initial outlay -72200
Net change in w/c -26000
Total time 0 cash flows -98200
Year 1 2 3 4 5 6
Addl.revenue due to expansion 105000 105000 105000 97000 88000 88000
Addl.operating costs(excl.depn.) -68000 -68000 -68000 -68000 -68000 -68000
Depreciation(DEP) -23826 -32490 -10830 -5054 0 0
EBIT(or opg.inc.) 13174 4510 26170 23946 20000 20000
Taxes on opg. Inc. -5269.6 -1804 -10468 -9578 -8000 -8000
After-tax project opg. Inc.(OI) 7904.4 2706 15702 14368 12000 12000
Opg. Cash flow(OI+DEP) 31730.4 35196 26532 19422 12000 12000
Recovery of W/c 98200
Salvage after-tax 840
Project net cash flows
(opg.+non-opg.) -98200 31730.4 35196 26532 19422 12000 111040
NPV(Excel fn.) 52481.923
Verification of NPV as per Excel
PV F at 12% 1 0.892857 0.797194 0.71178 0.635518 0.567427 0.506631
PV at 12% -98200 28330.71 28058.04 18884.95 12342.78 6809.122 56256.32
NPV 52481.923
AAPL-E-- Highest annual operating cost to net a NPV of $1 is 89274.9 (in '000 $)
Year 1 2 3 4 5 6
Addl.revenue due to expansion 105000 105000 105000 97000 88000 88000
Addl.operating costs(excl.depn.) -89274.9 -89274.9 -89274.9 -89274.9 -89274.9 -89274.9
Depreciation(DEP) -23826 -32490 -10830 -5054 0 0
EBIT(or opg.inc.) -8100.922 -16764.9 4895.078 2671.078 -1274.92 -1274.92
Taxes on opg. Inc. 3240.3689 6705.969 -1958.03 -1068.43 509.9689 509.9689
After-tax project opg. Inc.(OI) -4860.553 -10059 2937.047 1602.647 -764.953 -764.953
Opg. Cash flow(OI+DEP) 18965.447 22431.05 13767.05 6656.647 -764.953 -764.953
Recovery of W/c 98200
Salvage after-tax 840
Project net cash flows
(opg.+non-opg.) -98200 18965.447 22431.05 13767.05 6656.647 -764.953 98275.05
NPV(Excel fn.) 0.001
Verification of NPV as per Excel
PV F at 12% 1 0.8928571 0.797194 0.71178 0.635518 0.567427 0.506631
PV at 12% -98200 16933.435 17881.89 9799.112 4230.419 -434.055 49789.2
NPV 0.001
AAPL-F (other assumptions as in E
Cost of capital 26.65%
b. Project's net Time 0 Cash flows
Total initial outlay -72200
Net change in w/c -26000
Total time 0 cash flows -98200
Year 1 2 3 4 5 6
Addl.revenue due to expansion 105000 105000 105000 97000 88000 88000
Addl.operating costs(excl.depn.) -68000.0 -68000 -68000 -68000 -68000 -68000
Depreciation(DEP) -23826 -32490 -10830 -5054 0 0
EBIT(or opg.inc.) 13174 4510 26170 23946 20000 20000
Taxes on opg. Inc. -5269.6 -1804 -10468 -9578 -8000 -8000
After-tax project opg. Inc.(OI) 7904.4 2706 15702 14368 12000 12000
Opg. Cash flow(OI+DEP) 31730.4 35196 26532 19422 12000 12000
Recovery of W/c 98200
Salvage after-tax 840
Project net cash flows
(opg.+non-opg.) -98200 31730.4 35196 26532 19422 12000 111040
NPV(Excel fn.) 0.000
IRR
Verification of NPV as per Excel
PV F at 26.65% 1 0.7895776 0.623433 0.492249 0.388668 0.306884 0.242309
PV at 26.65% -98200 25053.612 21942.34 13060.34 7548.562 3682.606 26905.95
NPV -6.595

IRR=26.65%

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