Question

1) Use an Excel spreadsheet to evaluate the Pear Computer Company proposal. 2) Conduct a sensitivity analysis that focuses on the cost of capital. For a best case scenario, decrease the cost of capital by three percentage points. For a worst case scenario, increase the cost of capital by three percentage points. 3) You must provide one spreadsheet for each of the three situations—the base case estimate, the best case, and the worst case. 4) What do you recommend? Explain. You may type your recommendation and explanation on the Excel sheet.

Pear Computer’s research and development (R&D) department has developed a proposal for a new generation of tablet-sized computers. 1. Project’s useful life: 4 years. 2. Capital expenditures: $25,000,000. 3. Depreciation: straight-line over 4 years. 4. Sales: 25000 units in year 1, 95,000 in year 2, 70,000 in year 3, 25,000 in year 4. The sales price is expected to remain constant at $580. 5. Cost of goods sold (not counting depreciation): 60% of sales. 6. Selling, general and administrative expenses: $1,500,000 the first year, $1,750,000 the second year, $1,000,000 the third, and $500,000 the 4th . 7. R&D: $1,500,000 spent one year ago. 8. Initial investment in net working capital: $1,250,000. Then it increases by $10,000 for each of three years and finally is fully recovered in the final year. 9. Tax rate: 38%. 10. Cost of Capital: 14%

Answer 1

Answer 1:

Base Case:

Answer 2 (a):

Sensitivity analysis:

Best Case:

Cost of capital = 14% - 3% = 11%

Answer 2(b)

Worst case:

Cost of capital = 14% + 3% = 17%

Answer 3:

Separate evaluations as required are given in above answers.

Answer 4:

As we observe above:

Base case NPV is positive at $1,746,303.92

Worst case NPV is also positive at $47,632.78

Hence Project should be accepted.