Capital Budgeting Case Study Fin 350

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Benjamin Simontov, Francesca Elena Di Majo, Martina Lersa, Elisabetta Delpiano

Memo: Capital Budgeting Case Study

FIN 350, Section: D

11/15/17

Memo: (All values

1. We obtained IBM’s financial statements, and copied their annual income statement and balance sheet for the last four years, onto Excel.
2. We computed the FCF’s for each year:
1. We found the 2016 ratio of non-depreciation by using the formula (Cost of Revenue, Total + SG&A + R&D)/Total Revenue [(\$41,624+\$19,640+\$5,751)/\$79,919] = 0.838537.
2. We then determined the annual depreciation of those assets by using the MACRS 5-year depreciation schedule (as provided). These came out as:
1. t0 (20%) = \$170,000,000, t1 (32%) = \$272,000,000, t2 (19.20%) = \$163,000,000, t3 (11.52%) = \$97,920,000, t4 (11.52%) = \$97,920,000, t5 (5.76%) = \$48,960,000 (the book value of at t=5 is zero).
1. Using Google Finance, we found the 2016 Income After Tax and Income Before Tax and used the formula: 1- (Income After Tax/Income Before Tax), to find IBM’s effective tax rate. [1 - (\$11,881/\$12,330)] = 0.03641524 or Approx. 3.642%.
1. This ratio was later multiplied by Depreciation, and then added to (Sales – Costs)*(1 – t) to find Cash Flows. (See Excel).
1. We calculated NWC first by finding IBM’s 2016 NWC/Sales ratio: [(\$9,182 + \$1,553) - \$6,209)]/\$79,919 = 0.05663234 or approximately 5.663%. We used this ratio to determine Cash Flows for each year, by multiplying the ratio by projected sales of the given year. We got: t0 = \$169,897,020.00, t1 = \$203,876,424.00, t2 = \$224,264,066.40, t3 = \$168,198,049.80, t4 = \$117,738,634.86, and t5 = 0.
1. To determine the IRR and NPV we first needed to calculate the FCF. We had already calculated the NWC and Cash Flows, but still needed to add CAPEX to the equation. CAPEX was given as an outflow of \$850 million. FCF therefore became: t0 = -\$1,013,706,428.01, t1 = \$442,676,785.67, t2 = \$545,656,816.89, t3 = \$675,743,437.66, t4 = \$516,108,925.98, and t5 = \$442,980,136.39.
1. To find IRR, set  = 0 and solve for r. R = .424847, or approx. 42%. IRR > 12%, should accept.[pic 1]
2. To find NPV use equation, but set r to 12% (provided cost of capital):  = \$876,871,186.06. NPV > 0, should accept.  [pic 2]
1. Sensitivity Analysis: (See Excel values for details)
1. To calculate the sensitivity of each NPV, we multiply the Initial Sales by the percentages provided by the text. We find that that the tipping point is 50%, anything below that value, will result in a negative NPV.
2. To calculate the NPV when costs are 2% higher, or lower, we added (and subtracted) 2% to/from the initial Cost Ratio.
1. 2% lower, the NPV was > 0 at \$1,097,229,303.32. The IRR was 35%.
2. 2% higher, the NPV was > 0 at \$656,513,068.82. The IRR was 50%.

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