Finance Case Study - Capital Budgeting Case

Capital Budgeting Case: Part I

I. Instructions: This case is designed to be an excel spreadsheet case. Please show your work by using

formulas and cell references in excel. Use the excel spreadsheet template that is available on Blackboard,

under Assignments, for more details. Please show your work for the sensitivity analysis in question #2 in

a separate sheet in excel. You may round to two decimal places in your calculations.

Suppose Sunshine Outfitters, Inc., is considering the following project, where all of the dollar

figures are in thousands of dollars.

 In year 0, the project requires an $11,500 investment in plant and equipment. This

equipment is depreciated using the straight-line method over seven years, and has a

salvage value (after-tax) of $1,200 in year 7.

 The project is expected to generate sales of 3,000 units in year 1. Details on the annual unit

sales are given in the spreadsheet template, highlighted in yellow.

 Sales revenue per unit is forecast to be $10.00 in year 1 and then grow with inflation.

 Variable cost per unit is forecast to be $7.50 in year 1 and then grow with inflation.

 Cash fixed costs are forecast to be $5,280 in year 1 and then grow with inflation.

 The inflation rates that apply each year (to sales, VC, and FC) are shown in the spreadsheet.

 The company uses a 13.2% discount rate to evaluate new product decisions.

 The tax rate is forecast to be a constant 35.0%.

 The project will require working capital in the amount of $0.90 in year 0 for every unit of

next year's forecasted sales, and this amount ($0.90) will grow with inflation going forward.

1) What is the project's NPV? What is the IRR? Would you accept this project?

2) Suppose you need to do some sensitivity analysis (please show on separate worksheet):

(a) What if the firm suspects that this project is riskier than the firm's average project and

decides to increase the cost of capital to 15%. What is the NPV?

(b) What if the firm fears that its variable costs may be higher than estimated? What if the

variable cost/unit starts off at $8.10 in year 1, and then grows with inflation – what is the

NPV?

II. Part II

SoccerBalls, Inc.

As a financial analyst for SoccerBalls, Inc., you must provide an opinion on a proposed capital

budgeting project for the firm. The firm is contemplating the use of a new, softer and smoother

type of material in its soccer balls. You and your fellow analysts have come up with estimates

about the market for such a soccer ball (see below), which would be marketed largely to younger

players to minimize the risk of injury. The company expects to sell the soccer balls for six years.

The equipment required to manufacture the balls has zero salvage value. The required rate of

return for the project is expected to be 10%. The company has a 40% tax rate. Would you

recommend this project?

Pessimistic Expected Optimistic

Market size 900,000 1,000,000 1,100,000

Market share 20% 24% 27%

Selling price $22 $25 $28

Variable costs/unit $8 $7 $6

Fixed costs/year $1,000,000 $950,000 $900,000

Initial investment (at

t=0) $2,000,000 $1,900,000 $1,850,000

Note: The market size refers to the entire market for soccer balls (i.e., 900,000 balls); the market share is

the percent of the market that the firm expects to capture (i.e., 20% of 900,000).