Ross, Westerfield, and Jordan's Spreadsheet Master Essentials of Corporate Finance, 7 th edition by Brad Jordan and Joe Smolira

Version 7.0

Chapter 9
Naming cells SLN VDB

In these spreadsheets, you will learn how to use the following Excel f

Scenario Manager
One-way Data Table Solver

The following conventions are used in these spreadsheets: 1) Given data in blue 2) 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 Office button then "Excel Options," "Add-Ins" and select "Go." Check "Analysis ToolPak" and "Solver Add-In," then click "OK."

the following Excel functions:

adsheets:

Chapter 9 - Section 3 Pro Forma Financial Statements and Cash Flows

Because capital budgeting requires numerous repetitive cash flows, it is an ideal application for Excel. When doing should do few or no calculations on your own, but rather let Excel do the calculations for you. We will begin with th projections for the project: Cans sold per year: Price per can: Variable cost per can: Required return: Fixed costs per year: Manufacturing equipment: Project life (years): Initial net working capital: Tax rate: 50,000 4.00 2.50 20% 12,000 90,000 3 20,000 34%

$ $ $ $ $

RWJ Excel Tip In a problem with a number of different variables, it can be advantageous to name the cells. Click on the input cell the Formula bar in the name bar and you will see the name "Units." We entered the name in the name bar to nam from this cell later, we can type in the name of the variable instead of referencing the cell. For example, if you look formula we used in this cell is Units * Price_per_unit. When naming cells, you should keep the names short but und the variable name, so we used an underscore instead of the space in Price_per_unit.

With these numbers, we can prepare the pro forma income statement, which will be: Sales Variable costs Fixed costs Depreciation EBIT Taxes (34%) Net income $ 200,000 125,000 12,000 30,000 33,000 11,220 21,780

$ $

RWJ Excel Tip To calculate the depreciation each year for straight-line depreciation, we can divide the initial cost by the life of th as we have done here. The SLN inputs we used in this case looks like this:

The inputs are Cost, which is the initial cost, Salvage, which is the salvage value, and Life, which is the life of the ass cost by the life of the equipment in the cell rather than use this particular function, but it is available if you prefer.

Average Accounting Return To calculate the AAR, we need the average investment in assets each year. The total investment each year will be: Year 1 20,000 $ 60,000 80,000 $

Net working capital Net fixed assets Total investment

$ $

0 20,000 $ 90,000 110,000 $

2 20,000 30,000 50,000

So, the average assets are: Average assets: $ 65,000

Now, we can calculate the operating cash flow each year, which will be: EBIT + Depreciation - Taxes Operating cash flow $ 33,000 30,000 11,220 51,780

So, the total cash flow for each year of the project will be: Year 0 Operating cash flow Changes in NWC Capital spending Total project cash flow $ $ $ (20,000) (90,000) (110,000) $ 1 51,780 $ 2 51,780

51,780 $

51,780

Given these cash flows, we can now calculate the NPV, IRR, and AAR of the project, which are: NPV IRR AAR $ 10,647.69 25.76% 33.51%

l application for Excel. When doing a capital budgeting problem, as in most Excel uses, you ations for you. We will begin with the shark attractant project. We have the following

me the cells. Click on the input cell for the number of cans sold per year, and look to the left of d the name in the name bar to name the input in this cell. Whenever we want to use the input ng the cell. For example, if you look at the sales calculation below, you will see that the hould keep the names short but understandable. In addition, Excel does not allow spaces in _unit.

ivide the initial cost by the life of the equipment, or we can use the built-in Excel function SLN

and Life, which is the life of the asset. In general, we usually find it easier just to divide the ion, but it is available if you prefer.

total investment each year will be:

$ $

3 20,000 20,000

$ $ $

3 51,780 20,000 71,780

ect, which are:

Chapter 9 - Section4 More about Project Cash Flow

In practice, many assets are depreciated on a MACRS schedule for tax purposes. The three-, five-, and seven-year M Property Class 5- year 20.00% 32.00% 19.20% 11.52% 11.52% 5.76%

Year 1 2 3 4 5 6 7 8

3-year 33.33% 44.45% 14.81% 7.41%

7-year 14.29% 24.49% 17.49% 12.49% 8.93% 8.92% 8.93% 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: MACRS percentage Depreciation 20.00% $ 2,400.00 32.00% 3,840.00 19.20% 2,304.00 11.52% 1,382.40 11.52% 1,382.40 5.76% 691.20 100.00% $ 12,000.00

Year 1 2 3 4 5 6

To find the book value of the asset, we subtract depreciation each year from the beginning book value. The book v Beginning Ending book value Depreciation book value $ 12,000 $ 2,400.00 $ 9,600.00 9,600.00 3,840.00 5,760.00 5,760.00 2,304.00 3,456.00 3,456.00 1,382.40 2,073.60 2,073.60 1,382.40 691.20

Year 1 2 3 4 5

691.20

691.20

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 calculate the taxes on the sale of the asset is (Book value - Market value)(Tax rate). Suppose the pretax salvage valu Pretax salvage value: Tax rate: $ 3,000 34%

The aftertax salvage value, and therefore net cash flow from selling the asset at the end of the project (Year 6 in th Pretax salvage value: Taxes on sale: Aftertax salvage value: $ $ 3,000.00 (1,020.00) 1,980.00

The Majestic Mulch and Compost Company (MMCC)

The MMCC capital budgeting problem is a more in-depth analysis. As before, we want to put all inputs in a separat entering the data in rows for each variable, we could enter the data in columns as well. The input information for t Year Units sales Price NWC to start NWC % of sales Variable cost Fixed costs Equipment MACRS Pretax salvage value Tax rate Required return 1 $ $ $ $ $ 3,000 120 $ 20,000 15% 60 25,000 800,000 14.29% 20% 34% 15% 2 5,000 120 $ 3 6,000 120 $ 4 6,500 110

24.49%

17.49%

12.49%

We will calculate the operating cash flow first, which we can calculate as net income plus depreciation. So, the pro year will be: Pro Forma Income Statements 4 $ 715,000.00 390,000.00 25,000.00 99,920.00 $ 200,080.00 68,027.20

Year Revenues Variable costs Fixed costs Depreciation EBIT Taxes (34%)

1 2 $ 360,000.00 $ 600,000.00 $ 180,000.00 300,000.00 25,000.00 25,000.00 114,320.00 195,920.00 $ 40,680.00 $ 79,080.00 $ 13,831.20 26,887.20

3 720,000.00 360,000.00 25,000.00 139,920.00 195,080.00 66,327.20

Net income + Depreciation OCF

26,848.80 $ 52,192.80 $ 128,752.80 $ 132,052.80 114,320.00 195,920.00 139,920.00 99,920.00 $ 141,168.80 $ 248,112.80 $ 268,672.80 $ 231,972.80

RWJ Excel Tip Notice that in the income statements, we were careful to use absolute references in the variable costs, fixed costs, the equations to calculate the net income during the first year, we simple copied and pasted the year 1 net income

Next, we will calculate the change in net working capital. One way to do this is to calculate the difference between to remember that the net working capital at the end of the project will be zero. So, the net working capital require Year Initial NWC Ending NWC NWC cash flow 0 (20,000) $ (20,000) $ 1 20,000.00 $ 54,000.00 (34,000.00) $ 2 3 54,000.00 $ 90,000.00 90,000.00 108,000.00 (36,000.00) $ (18,000.00)

$ $

To find the aftertax salvage value, we need to calculate the taxes. We get: Pretax salvage value: Taxes on sale: Aftertax salvage value: $ 160,000.00 (54,400.00) $ 105,600.00

So, the total cash flows for each year of the project are: Project Cash Flows Year OCF Change in NWC Capital spending Total cash flow 1 2 3 $ 141,168.80 $ 248,112.80 $ 268,672.80 (20,000) (34,000.00) (36,000.00) (18,000.00) (800,000) (820,000) $ 107,168.80 $ 212,112.80 $ 250,672.80 0

$ $ $

Finally, the NPV and IRR of the project are: NPV: IRR: $ 65,484.83 17.24%

A Note on MACRS Depreciation

There are actually six MACRS schedules, three-, five-, seven-, 10-, 15-, and 20-year schedules. The MACRS schedule declining balance method, and switching to straight-line depreciation when it is more advantageous. The three-, fiv when calculating the double declining balance depreciation amount, while the 15- and 20-year schedules use a fac used to construct a MACRS table. Below, we have constructed a MACRS table with all six schedules. Equipment Life (Years)
Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 3 33.33% 44.44% 14.81% 7.41% 5 20.00% 32.00% 19.20% 11.52% 11.52% 5.76% 7 14.29% 24.49% 17.49% 12.49% 8.92% 8.92% 8.92% 4.46%

RWJ Excel Tip To construct the MACRS table, we used the variable declining balance (VDB) function. Constructing the MACRS tab 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 t zero. Life is the life of the asset. Since we have a table here, we entered the column as a floating input and locked t down the table was well as across. The Start_period is the starting period for which we want to calculate the depre subtracted 1/2. To calculate the End_period, we used the MIN function. This function will return the lesser of the n years we could have taken the next year minus one-half, but this would not work for the last year. Notice that this prior year. So, for the first year, we eliminated the MIN function. Finally, the Factor is not shown on the picture abo 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

Finally, note that the MACRS schedule is slightly different from the table presented in the textbook for the 6th and that the IRS publishes a MACRS schedule, which is the schedule we used in the textbook. However, you are allowed outlined by the IRS. If you do so, you will get the table above, not the table in the textbook (or the table published textbook for our calculations.

The three-, five-, and seven-year MACRS schedules are:

ation and the initial cost is:

beginning book value. The book value of this asset each year will be:

alue, or a tax rebate will be given if the asset is sold for less than book value. An easy way to e). Suppose the pretax salvage value of the asset and the tax rate are:

he end of the project (Year 6 in this case) will be:

want to put all inputs in a separate cell and have Excel handle all the calculations. While we are s well. The input information for the MMCC line of power mulching tools is: 5 $ 6,000 110 $ 6 5,000 110 $ 7 4,000 110 $ 8 3,000 110

8.93%

8.92%

8.93%

4.46%

me plus depreciation. So, the pro forma income statements each

Forma Income Statements 5 6 7 8 $ 660,000.00 $ 550,000.00 $ 440,000.00 $ 330,000.00 360,000.00 300,000.00 240,000.00 180,000.00 25,000.00 25,000.00 25,000.00 25,000.00 71,440.00 71,360.00 71,440.00 35,680.00 $ 203,560.00 $ 153,640.00 $ 103,560.00 $ 89,320.00 69,210.40 52,237.60 35,210.40 30,368.80

$ 134,349.60 $ 101,402.40 $ 68,349.60 $ 71,440.00 71,360.00 71,440.00 $ 205,789.60 $ 172,762.40 $ 139,789.60 $

58,951.20 35,680.00 94,631.20

s in the variable costs, fixed costs, depreciation, and tax cells. That way, once we entered all and pasted the year 1 net income column to the rest of the years.

calculate the difference between the beginning and ending net working capital. We also need o, the net working capital requirements each year are: 4 5 $ 108,000.00 $ 107,250.00 $ 107,250.00 99,000.00 $ 750.00 $ 8,250.00 $ 6 99,000.00 $ 82,500.00 16,500.00 $ 7 82,500.00 $ 66,000.00 16,500.00 $ 8 66,000.00 66,000.00

Project Cash Flows 4 5 6 7 $ 231,972.80 $ 205,789.60 $ 172,762.40 $ 139,789.60 $ 750.00 8,250.00 16,500.00 16,500.00

8 94,631.20 66,000.00 105,600.00 $ 232,722.80 $ 214,039.60 $ 189,262.40 $ 156,289.60 $ 266,231.20

ar schedules. The MACRS schedule is calculated using the depreciation according to the double more advantageous. The three-, five-, seven-, and 10-year schedules use a factor of 2 (200%) 5- and 20-year schedules use a factor of 1.5 (150%). Excel has a function, VDB, which can be h all six schedules.

Equipment Life (Years)

10 10.00% 18.00% 14.40% 11.52% 9.22% 7.37% 6.55% 6.55% 6.55% 6.55% 3.28% 15 5.00% 9.50% 8.55% 7.70% 6.93% 6.23% 5.90% 5.90% 5.90% 5.90% 5.90% 5.90% 5.90% 5.90% 5.90% 2.95% 20 3.75% 7.22% 6.68% 6.18% 5.71% 5.28% 4.89% 4.52% 4.46% 4.46% 4.46% 4.46% 4.46% 4.46% 4.46% 4.46% 4.46% 4.46% 4.46% 4.46% 2.23%

tion. Constructing the MACRS table is tricky because of the half-year convention. Below you

e answers as a percentage rather than a dollar amount. Salvage is the salvage value, which is mn as a floating input and locked the row. This allows us to copy and paste the formula further ch we want to calculate the depreciation. With the half-year convention, we used the year and ction will return the lesser of the next year minus one-half, or the life of the asset. In most for the last year. Notice that this MIN function will not work for the first year since there is no or is not shown on the picture above since Excel scrolls through the inputs in this case. We tor of 1.5 for the 15- and 20-year schedules.

ed in the textbook for the 6th and 8th year of the seven-year MACRS schedule. The reason is xtbook. However, you are allowed to calculate the schedule on your own based on the rules textbook (or the table published by the IRS!). In the future, we will use the table in the

Chapter 9 - Section 6 Scenario and Other What-If Analyses

Scenario Analysis Scenario analysis is used to determine the range of possible outcomes for a project. Typically, the base case, best c scenario analysis. Because of the repetitive nature of the calculations, spreadsheets are an excellent tool for doing in the textbook: Base case 6,000 80 60 50,000 200,000 5 12% 34%

Unit sales: Price per unit Variable costs per unit: Fixed costs per year: Initial cost: Project life (years): Required return: Tax rate:

$ $ $ $

With these values, we need to calculate the base case, best case, and worst case NPVs and IRRs. First, we want to c which are: Base Case Income Statement Sales $ 480,000 Variable costs 360,000 Fixed costs 50,000 Depreciation 40,000 EBIT $ 30,000 Taxes (34%) 10,200 Net income $ 19,800 OCF NPV IRR $ $ 59,800 15,566 15.10%

Notice, in this case we calculated the NPV and IRR using the PV function and RATE function rather than the NPV an year, we find this calculation easier. To calculate the best case and worst case, we will use Scenario Manager, which is described below. RWJ Excel Tip

Scenario Manager is a powerful tool that allows you to evaluate different scenarios and is useful in cases such as th cells that we will be changing, in this case cells D9 through D12. Next, go to the Data tab, click What-If Analysis, Sce

When you click on Add, another box comes up that will allow you to enter the scenario name. After entering the na this:

Notice two things about this box. First, the values are changed to the best case values. This is because the image w instead of cell names, i.e. D9, the variable in the cell comes up because we named each input cell, as well as the NP case, we simply clicked Add, then added the worst case scenario. When the values for both scenarios are entered, names which we have already added.

Now that all the scenarios are entered, we can click on Summary, which brings up the final box. This box allows us cells D32 (NPV) and D33 (IRR) as the final results we wanted Scenario Manager to calculate, then clicked OK. The re

Sensitivity Analysis In contrast to scenario analysis, sensitivity analysis holds all variables except one constant. This allows us to see how this case, we will perform sensitivity analysis using fixed costs, although all other variables could be similarly exami completed using a one-way data table. Below, you will see a table with the NPV for different levels of fixed costs: Fixed costs 25,000 30,000 35,000 40,000 45,000 50,000 55,000 60,000 65,000 70,000 NPV 75,044 63,149 51,253 39,357 27,461 15,566 3,670 (8,226) (20,122) (32,017)

$ $ $ $ $ $ $ $ $ $

$ $ $ $ $ $ $ $ $ $

75,000 $

(43,913)

Graphically, the relationship between fixed costs and NPV looks like this:

Sensitivity Analysis for Fixed Costs

$100,000 $80,000 $60,000 Net Present Value $40,000 $20,000 $$25,000 $30,000 $35,000 $40,000 $45,000 $(20,000) $(40,000) $(60,000)

As you can see, there is a negative relationship between fixed costs and project NPV. We would expect this: As cos decrease.

RWJ Excel Tip To set up a one-way data table, we need to first enter the inputs we want to use in the calculations in a column (or right and one cell above where the input values begin, we need to make the cell equal to the final value we want th that in our data table, this cell is C109. However, to make the data table look better, we have hidden this row. To u and then select "Unhide." This first step is to highlight the entire column with the numbers we want used in the cal the adjacent column. Next, select the "Data" tab, then "What-If Analysis," and "Data Table." Finally, enter the origi calculate the values in the data table, which is cell D12 for fixed costs.

We should note that when you create a data table, you can change the input cells in which you entered the new va of the data table.

Of course, in our sensitivity analysis, we could be interested in how the NPV changes when two input variables cha variables that would seem to be related since a higher cost would likely result in fewer units sold. In this case, we c the NPV for changes in both of these variables. (Two-way data tables were introduced in Chapter 5.) The sensitivity this: Price per Unit 5,000 5,200 5,400 5,600 5,800 6,000 6,200 6,400 6,600 6,800 7,000 $ $ $ $ $ $ $ $ $ $ $ $ 70 (150,975.04) (146,216.74) (141,458.43) (136,700.13) (131,941.83) (127,183.52) (122,425.22) (117,666.91) (112,908.61) (108,150.30) (103,392.00) $ $ $ $ $ $ $ $ $ $ $ $ 75 (91,496.24) (84,358.78) (77,221.32) (70,083.87) (62,946.41) (55,808.95) (48,671.50) (41,534.04) (34,396.58) (27,259.12) (20,121.67) $ $ $ $ $ $ $ $ $ $ $ $ 80 (32,017.43) (22,500.82) (12,984.21) (3,467.60) 6,049.01 15,565.62 25,082.23 34,598.84 44,115.44 53,632.05 63,148.66

As you can see, when the price drops below $80, the project has a negative NPV for all units sold examined, while t NPV for the range we examined in this table.

In the end, we are ultimately concerned with how sensitive the NPV is to changes in the inputs to the project. One how sensitive the NPV is to the same percentage change in the inputs. Below, we have constructed one-way data t that we believe will vary. Notice that we have the base case values as inputs in these tables. The reason is that if w the calculation of the ranges will create a loop. % Change from Base Case -30% -20% -10% 0% 10% 20% 30%

Units Sold

Units sales 4,200 4,800 5,400 6,000 6,600 7,200 7,800

$ $ $ $ $ $ $

NPV (70,083.87) (41,534.04) (12,984.21) 15,565.62 44,115.44 72,665.27 101,215.10

% Change from Variable cost Base Case per unit NPV -30% $ 42.00 $ 272,514.06 -20% $ 48.00 $ 186,864.58

-10% 0% 10% 20% 30%

$ $ $ $ $

54.00 60.00 66.00 72.00 78.00

$ 101,215.10 $ 15,565.62 $ (70,083.87) $ (155,733.35) $ (241,382.83)

To compare changes in each of the variables, we will graph the NPV for each of the sensitivity tables. Since the colu NPV columns, hold down the CTRL and ALT keys, then use the cursor to select the four columns. The sensitivity of t looks like this:

Sensitivity of NPV to Changes in Inputs

$400,000.00 $300,000.00

$200,000.00

Net Present Value

$100,000.00

$-30% $(100,000.00) -20% -10% 0% 10%

$(200,000.00)

$(300,000.00)

$(400,000.00)

Percentage Change from Base Case Value

As you can see, the line with the steepest slope is the price per unit, followed closely the variable cost per unit. Sin variables, we should concentrate our efforts in determining whether or not our estimates for these two variables a

ject. Typically, the base case, best case, and worst case values are calculated when doing eets are an excellent tool for doing the analysis. Consider the values presented in the example

e NPVs and IRRs. First, we want to calculate the NPV and IRR with the base case projections,

TE function rather than the NPV and IRR functions. When the cash flows are the same for each

is described below.

rios and is useful in cases such as this. To use Scenario Manager, we first need to select the Data tab, click What-If Analysis, Scenario Manager. This will bring up a box that looks like this:

cenario name. After entering the name, hit Add and another box will come up that looks like

values. This is because the image was captured after we had changed the values. Second, ed each input cell, as well as the NPV and IRR cells. After we entered the values for the best ues for both scenarios are entered, click OK. This brings us to another box with the scenario

up the final box. This box allows us to save the results in a separate spreadsheet. We entered to calculate, then clicked OK. The results are shown on the next tab.

e constant. This allows us to see how changes in one variable affects the NPV of a project. In er variables could be similarly examined. Using Excel, sensitivity analysis is most easily for different levels of fixed costs:

Analysis for Fixed Costs

$45,000 $50,000 $55,000 $60,000 $65,000 $70,000 $75,000

Fixed Costs

NPV. We would expect this: As costs increase, the value of the project should

e in the calculations in a column (or row). Since we have used a column here, one cell to the l equal to the final value we want the data table to calculate, or in this case, the NPV. Notice etter, we have hidden this row. To unhide this row, select both rows 108 and 110, right click, he numbers we want used in the calculation, as well as the final calculation cell at the top of "Data Table." Finally, enter the original cell that contains the variable we want to use to

ells in which you entered the new values to analyze, but you cannot change the size or layout

anges when two input variables change. Price and quantity sold are two n fewer units sold. In this case, we can use a two-way data table to compute oduced in Chapter 5.) The sensitivity analysis for price and units sold looks like

Price per Unit $ 85 $ 27,461.38 $ 39,357.14 $ 51,252.90 $ 63,148.66 $ 75,044.42 $ 86,940.19 $ 98,835.95 $ 110,731.71 $ 122,627.47 $ 134,523.23 $ 146,418.99

$ $ $ $ $ $ $ $ $ $ $ $

90 86,940.19 101,215.10 115,490.01 129,764.93 144,039.84 158,314.75 172,589.67 186,864.58 201,139.50 215,414.41 229,689.32

$ $ $ $ $ $ $ $ $ $ $ $

95 146,418.99 163,073.06 179,727.13 196,381.19 213,035.26 229,689.32 246,343.39 262,997.46 279,651.52 296,305.59 312,959.65

$ $ $ $ $ $ $ $ $ $ $ $

100 205,897.80 224,931.02 243,964.24 262,997.46 282,030.67 301,063.89 320,097.11 339,130.33 358,163.55 377,196.77 396,229.98

V for all units sold examined, while the units sold is not as important to the

es in the inputs to the project. One way we can examine this is to determine we have constructed one-way data tables for each of the inputs to our project these tables. The reason is that if we reference the original cells (D9 to D12),

% Change from Base Case -30% -20% -10% 0% 10% 20% 30%

Price per unit $ 56.00 $ 64.00 $ 72.00 $ 80.00 $ 88.00 $ 96.00 $ 104.00

$ $ $ $ $ $ $

NPV (327,032.31) (212,833.00) (98,633.69) 15,565.62 129,764.93 243,964.24 358,163.55

% Change from Base Case -30% $ -20% $

Fixed costs per year 35,000.00 $ 40,000.00 $

NPV 51,252.90 39,357.14

-10% 0% 10% 20% 30%

$ $ $ $ $

45,000.00 50,000.00 55,000.00 60,000.00 65,000.00

$ $ $ $ $

27,461.38 15,565.62 3,669.86 (8,225.91) (20,121.67)

the sensitivity tables. Since the columns we wish to graph are separated, to select the four he four columns. The sensitivity of the NPV to percentage changes in the base case values

Changes in Inputs

Unit sales Price per unit 20% 30% Variable cost per unit Fixed costs

Base Case Value

osely the variable cost per unit. Since the NPV is most sensitive to changes in these two estimates for these two variables are accurate.

Scenario Summary
Current Values: Best Case Worst Case

Changing Cells: Unit_sales 6,000 6,500 Price $ 80 $ 85 $ Variable_cost_per_unit $ 60 $ 58 $ Fixed_costs $ 50,000 $ 45,000 $ Result Cells: NPV $ 15,566 $ 159,504 $ IRR 15.10% 40.88% Notes: Current Values column represents values of changing cells at the time the Scenario Summary Report was created. Changing cells for each scenario are highlighted in gray.

5,500 75 62 55,000 (111,719) -14.40%

Chapter 9 Setting a Bid Price

Setting a Bid Price

Suppose you are in a competitive bid situation. If your bid is too high, your company will not get the project, but if project. So, what is the minimum bid price you would submit? The minimum bid price is the price that results in a z The contract will last for four years, and the equipment will be depreciated on a three-year MACRS schedule. What Equipment Pretax salvage value Units per year Price per unit VC as a percentage of sales Fixed costs MACRS Year 1 MACRS Year 2 MACRS Year 3 MACRS Year 4 Immediate NWC Tax rate Required return $ $ $ $ 3,300,000 75,000 125,000 25.00 45% 425,000 33.33% 44.44% 14.82% 7.41% 80,000 35% 10%

We entered a price in the appropriate cell above. As we will show later, it does not really matter what price we ent the project with our hypothetical price. This will be: Pro Forma Income Statements 2 3 $ 3,125,000 $ 3,125,000 1,406,250 1,406,250 425,000 425,000 1,466,520 489,060 $ (172,770) $ 804,690 (60,470) 281,642 $ (112,301) $ 523,049 1,466,520 489,060 $ 1,354,220 $ 1,012,109

Year Revenues Variable costs Fixed costs Depreciation EBIT Taxes (35%) Net income + Depreciation OCF

$ $ $

1 3,125,000 1,406,250 425,000 1,099,890 193,860 67,851 126,009 1,099,890 1,225,899

$ $ $

4 3,125,000 1,406,250 425,000 244,530 1,049,220 367,227 681,993 244,530 926,523

To find the aftertax salvage value, we need to calculate the taxes. We get: Pretax salvage value: $ 75,000.00

Taxes on sale: Aftertax salvage value:

(26,250.00) 48,750.00

The total cash flows for each year of the project are: Project Cash Flows 1 2 1,225,899 $ 1,354,220 $

Year OCF Change in NWC Capital spending Total cash flow

0 $ $ $ $ (80,000) (3,300,000) (3,380,000) $

3 1,012,109

1,225,899 $

1,354,220 $

1,012,109

Finally, the NPV of the project at this unit price is: NPV: $ 334,821.06

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 RWJ Excel Tip To use Solver, go to the Data tab, then click Solver. The inputs we used for this problem are:

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 c 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 this case, we changed the unit price cell. This is why the original value we entered for the unit price is irrelevant: So that after we used Solver, we restored the original value. On the next worksheet, you can see the answer report ge zero NPV is: Minimum bid price: $ 22.64

We restored the original unit price so you could use Solver on this problem for practice.

NOTE: There is a bug in Solver that will occur occasionally. In some cases, Solver will not launch, or if you try to sav unexpected internal error or available memory was exhausted" pop up. In this case, the solution is to uninstall Solv

1) Go to the Office button on the top left, click Excel options, choose Add-Ins, select Excel Add-Ins in the pulld 2) Uncheck the Solver add-in and click OK. 3) Go to the Office button on the top left, click Excel options, choose Add-Ins, select Excel Add-Ins in the pulld is a repeat of Step 1. 4) Check the Solver add-in and select OK.

ny will not get the project, but if your bid is too low, your company will lose money on the price is the price that results in a zero NPV. Suppose we are bidding on the following project. hree-year MACRS schedule. What is the minimum bid price we could submit?

ot really matter what price we entered. Next, we need to calculate the cash flows and NPV for

4 926,523 80,000 48,750 1,055,273

n use Solver to find this unit price (and much more.)

oblem are:

ecific value, in this case, the NPV cell. Since the lowest bid price is the price that results in a e cell we would like to change in order to set the target cell equal to the value we chose. In for the unit price is irrelevant: Solver will change the value when it solves the problem. Note you can see the answer report generated by Solver. In this case, the bid price that results in a

will not launch, or if you try to save one or more of the reports, you may see "Solver: An se, the solution is to uninstall Solver and re-install it. To do this:

s, select Excel Add-Ins in the pulldown menu near the bottom of the box, and click on Go.

s, select Excel Add-Ins in the pulldown menu near the bottom of the box, and click on Go. This

Microsoft Excel 12.0 Answer Report Worksheet: [Chapter 9.xlsx]Setting a Bid Price Report Created: 11/20/2008 5:35:12 PM

Target Cell (Value Of) Cell Name $C$55 NPV: Project Cash Flows

Original Value $ -

Final Value $ -

Adjustable Cells Cell Name $D$11 Price per unit

Original Value Final Value $ 22.64 $ 22.64

Constraints NONE

Chapter 9 - Master it!

For this Master It! assignment, refer to the Conch Republic Electronics case at the end of Chapter 9. For your case such as the price, variable cost, etc. on the next page. For this project, answer the following questions: a. b. c. d. e. What is the profitability index of the project? What is the IRR of the project? What is the NPV of the project? How sensitive is the NPV to changes in the price of the new PDA? Construct a one way data table to help you How sensitive is the NPV to changes in the quantity sold?

e at the end of Chapter 9. For your convenience, we have entered the relevant values in the t, answer the following questions:

ct a one way data table to help you answer this question.

Master it! Solution

Equipment Pretax salvage value R&D Marketing study $ $ $ $ 32,500,000 3,500,000 750,000 200,000 Year 1 65,000 80,000 15,000 14.29% $ $ $ 500 215 4,300,000 35% 20% 12% Year 2 82,000 60,000 15,000 24.49% Year 3 108,000 Year 4 94,000

Sales (units) Sales of old PDA Lost sales Depreciation rate Price VC FC Tax rate NWC percentage Required return

17.49%

12.49%

Year 1 Sales VC Fixed costs Dep EBT Tax NI +Dep OCF NWC Beg End NWC CF Net CF Salvage BV of equipment Taxes

Year 2

Year 3

Year 4

Salvage CF Time 0 1 2 3 4 5 a. b. c. d. Profitability index IRR NPV Price per unit $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ DNPV/DPrice e. To find the sensitivity of the NPV to changes in quantity, we need to change the quantity sold manually since year's qauntity sold, the NPV is: 400 410 420 430 440 450 460 470 480 490 500 510 520 530 540 550 560 570 580 590 600 NPV Cash flow

NPV DNPV/DQuantity

Year 5 57,000

8.93%

Year 5

uantity sold manually since the quantity sold is different each year. If we add 100 units to each