2. 2
Contents
Executive Summary ............................................................................................................................3
Part A –NPV, IRR, MIRR, and PI............................................................................................................4
Part B – NPV profile chart....................................................................................................................4
Part C – Sensitivity Analysis.................................................................................................................5
Part D – Weighted Probabilities...........................................................................................................5
Part E – Solver Solutions......................................................................................................................6
Part F – CAPM ....................................................................................................................................7
3. 3
Executive Summary
We are planning to develop a powerful new server for internet activities. After analysis
and consideration, I confidently believe that the following project should be rejected based off
of my findings.
The project will have an initial cost of $6,933,333.33 for equipment, networking capital,
and flotation costs. This is a 6 year project existing of 6 different cash flows. One unit will sell
for $18 and a variable cost per unit of $12. I am expecting 400,000 units to be sold in year one
and an annual growth in unit sales to grow 4% a year at base case, 2% growth at worst case,
and 6% growth per year at the best case. Our flotation costs for the project are 6.25%, while
the WACC is 11.25%. MIRR for this project is 11.40% and the profitability index is 1.01.
After putting together an NPV profile I concluded that the NPV of this project would be
$54,791.93 at base case and a 50% probability. While it is great to have a positive NPV and the
overall goal of the firm is to increase our revenue, you must take in account that this is over a 6
year time period. The company would be spending 6,933,333.33 in initial costs just to kick start
the project. In the worst case with a 25% chance the project will return ($230,789.19) which
would be a massive loss for us. At best case the company where the probability is 25% the
project would return $354,779.91.
I would reject this project based off of these main points. The NPV of $54,791.93 is an
extremely small fraction (.007% to be exact) of the initial cost amount of $6,933,333.33.
Assuming there is a 25% chance that you could potentially lose $230,789.19 is also a major
factor as to why I would avoid this project. I have also calculated the break-even units sold for
the projects NPV to be equal to zero and found that just 396,682.15 units would cause the
project to have an NPV of zero. Essentially, if the projected sales units happened to be off by
just .08% than the project would have an NPV of zero. This could very easily happen in today’s
economy and is a risk I would advise against. Additionally, the break-even price per unit is
$17.95, inferring that just a $.05 difference would cause the NPV to equal zero. Again, in
today’s economy profit margins are ever changing and costs rise and fall daily. The sensitivity
off these variables is too risky to go forth with the project and I highly advise rejecting.
4. 4
Part A –NPV, IRR, MIRR, and PI
I would recommend rejecting this project based off the following criteria. To start, the projects
NPV is greater than 0, and in fact is $54,791.93. Although this is a positive outcome, $54,791.93
is only a very small fraction of the ($6,933,333.33) initial investment. Since the project lasts 6
years I would reject because the benefits of $54,791.93 are not enough to justify spending
($6,933,333.33) up front. Unless the equipment costs will be used in later projects down the
road or already existed than this project may be worth it, otherwise, reject. The risk is too
much.
Part B – NPV profile chart
After constructing my NPV profile chart, you can clearly see that as the WACC increases the
NPV will fall. Your breakeven WACC would be 11.49 (formulated with solver). From a business
perspective, you would want to lower your WACC as much as possible to achieve the highest
NPV possible. You can also see that a small fluctuation in the WACC will cause the NPV to react
very sensitively.
Net Present Value (NPV) 54,791.93$
IRR 11.49%
MIRR 11.40%
PI 1.01
NPV Profile forHarris Inc.
WACC NPV
0% $3,506,675.09
1.00% $3,106,934.75
2.00% $2,729,272.46
3.00% $2,372,193.43
4.00% $2,034,320.05
5.00% $1,714,381.59
6.00% $1,411,204.86
7.00% $1,123,705.78
8.00% $850,881.74
9.00% $591,804.71
10.00% $345,614.99
11.00% $111,515.55
12.00% ($111,233.19)
13.00% ($323,317.97)
14.00% ($525,376.97)
15.00% ($718,003.74)
16.00% ($901,750.65)
17.00% ($1,077,132.21)
18.00% ($1,244,627.95)
19.00% ($1,404,685.12)
20.00% ($1,557,721.19)
NPV Profile Data
($2,000,000.00)
($1,000,000.00)
$0.00
$1,000,000.00
$2,000,000.00
$3,000,000.00
$4,000,000.00
0% 5% 10% 15% 20% 25%
NPV
WACC
NPV Profile
B/E Wacc 11.57
5. 5
Expected NPV $58,393.64
Standard Deviation of NPV $207,061
Expected IRR 11.5%
Standard Deviation of IRR 0.92%
Expected PI 1.01
Standard Deviation of PI 0.030
Expected MIRR 11.399%
Standard Deviation of MIRR 0.55%
Part C – Sensitivity Analysis
At base case, where growth is 4%, your NPV is $54,791.93. A positive NPV does not always
indicate that you should accept the project. At worst case, where growth is only 2%, the NPV is
($230,789.19). This means that the project would cost the company ($230,789.19) and would
have a negative outcome. At best case, where growth is 6%, NPV shoots up to $354,779.91.
Therefore, if growth is more likely to stay at base case or above, you should go forth with the
project, but only if your growth stays well above 4%. I still advise to reject because there is no
definitive growth rate for the future and the risk of losing ($230,789.12) is too great for a
company that is risk averse.
Part D – Weighted Probabilities
After applying weights, I would conclude that the project should still be rejected. The new
expected NPV would be 58,393.64 which is higher than the previous NPV and is still positive,
but this is still just a small fraction of the ($6,933,333.33) initial investment. The IRR stays very
similar to the base case at 11.5% compared to 11.49%. The PI continues to round to 1.01,
which is exactly the same as the original base case. There is also no change in the MIRR,
therefore I can conclude that I would still reject this project based off the similarities in the
NPV, PI, IRR, and MIRR.
6. 6
Part E – Solver Solutions
Break-Even Quantity sold
i. Solver concluded that the breakeven unit sales can go as low as 396,682.15 units.
When you take into consideration that the projected units sold is 400,000, I would
say that this breakeven units is way too close to the projected unit sales. If the
projections of 400,000 are just .08% off, than the project would not even breakeven.
In my opinion the uncertainty of how many units will be sold is too risky.
Break-Even Unit Price
ii. Solver concluded that the breakeven unit price is $17.95. This is just 5 cents off from
the unit price in the base case of $18. The fact that this small of a change in unit
price could be the difference between breaking even and have a small profit of
$54,791.93 is way too risky and unstable.
Break-Even Debt to Equity Ratio
iii. Solver concluded that the breakeven debt to equity ratio would be .52535. The
model reflected high sensitivity to changes in the capital structure. Reducing debt
will increase your costs because debt is cheaper, therefore, bringing the NPV to 0.
While keeping the base model constraints.
Part E(Solver) Solutions
Units sold to B/e 396,682.15 units
Breakeven unit price 17.95$
Breakeven D/E ratio 0.52535
Breakeven unit cost 12.05$
Tax rate B/e 41%
B/e WACC 11.57%
7. 7
Equity Beta Debt Equity D/E Ratio Unlevered Beta
Company A 2.25 0.25 0.75 0.33 1.88
Company B 2 0.4 0.6 0.67 1.43
Company C 1.6 0.5 0.5 1.00 1.00
Company D 1.3 0.15 0.85 0.18 1.18
Company E 2.5 0.45 0.55 0.82 1.68
Unlevered 1.43
RfR 0.025 Levering Beta 2.29
MRP 0.0624
Debt (Wt.) 0.5
Equity (Wt. 0.5
Levered Beta 2.29
Project Discount Rate 16.79%
Re-estimated NPV (985,766.43)$
Part F – CAPM
i. The project specific discount rate is 16.79%, which is greatly bigger than the 11.25% WACC
of the base case. This tells us that when the industry average beta is combined with Harris
Inc’s capital structure that the risk increases greatly. This 5.54% difference is massive when
comparing the risk between the two.
ii. You can see below that the re-estimated NPV is ($985,766.43). This project would be
immediately rejected considering a massive loss close to a million dollars.
iii. The biggest benefit to CAPM is that you can compare and contrast the industry wide beta
compared to your own company’s capital structure. Therefore, giving you another outlook
on a project or idea. It helps capture the additional costs that occurs when taking on less
debt to take on more equity and then compares this to the market.
