Ross, Westerfield, Jaffe, and Jordan's Spreadsheet Master

Corporate Finance, 11th edition

by Brad Jordan and Joe Smolira
Version 11.0

Chapter 6
In these spreadsheets, you will learn how to use the following Excel fu
VDB
SLN
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 File tab
then "Excel Options," "Add-Ins" and select
"Go." Check "Analysis ToolPak" and
"Solver Add-In," then click "OK."
 the following Excel functions:

eadsheets:

equire that
 Chapter 6 - Section 2
The Baldwin Company: An Example

Because capital budgeting requires numerous repetitive cash flows, it is an ideal application for Excel. When doing a
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:

Year 1 Year 2 Year 3

Units sold per year: 5,000 8,000 12,000
Price per unit for Year 1: $ 20.00
Price increase per year: 2%
Inflation rate: 5%
Tax rate: 34%
Unit production cost for Year 1: $ 10.00
Increase in unit cost per year: 10%
NWC to start project: $ 10,000
NWC for subsequent years: 10%
Depreciation rate: 20.0% 32.0% 19.2%
Cost of machine $ 100,000
Cost of warehouse: $ 150,000
Pretax salvage value: $ 30,000

We will start off with some preliminary work, including the depreciation each year, sales price, and unit costs:

Year 1 Year 2 Year 3

Depreciation $ 20,000 $ 32,000 $ 19,200
Accumulated depreciation 20,000 52,000 71,200
Adjusted basis of machine 80,000 48,000 28,800
Price per unit 20.00 20.40 20.81
Sales revenue 100,000 163,200 249,696
Cost per unit 10.00 11.00 12.10
Operating costs 50,000 88,000 145,200

The change in net working capital for each year is the beginning net working capital for each year minus the net wor
change in net working capital each year is:

Net working capital

Beginning NWC $ 10,000 $ 10,000 $ 16,320
End of year NWC 10,000 16,320 24,970
NWC cash flow $ - $ (6,320) $ (8,650)
The machine will have a salvage value at the end of the project, but we are concerned with the aftertax salvage valu

Pretax salvage value $ 30,000

Taxes on sale 8,228
Aftertax salvage value $ 21,772

Now we can calculate the pro forma income statement for each year (Table 6.1), which will be:

Sales revenue $ 100,000 $ 163,200 $ 249,696

Operating costs 50,000 88,000 145,200
Depreciation 20,000 32,000 19,200
Income before taxes $ 30,000 $ 43,200 $ 85,296
Taxes at 34 percent 10,200 14,688 29,001
Net income $ 19,800 $ 28,512 $ 56,295

With this, the incremental cash flows each year, NPV for different interest rates, and IRR for the project are (Table 6

Year 0 Year 1 Year 2

Sales revenue $ 100,000 $ 163,200
Operating costs 50,000 88,000
Taxes 10,200 14,688
Cash flow from operations $ 39,800 $ 60,512
Bowling ball machine $ (100,000)
Warehouse $ (150,000)
Net working capital (10,000) - (6,320)
Total cash flow of project $ (260,000) $ 39,800 $ 54,192

NPV
4% $ 123,643
10% $ 51,590
15% $ 5,473
15.68% $ 0
20% $ (31,350)

A Note about Depreciation

There are actually six MACRS schedules: three-, five-, seven-, 10-, 15-, and 20-year schedules. The MACRS schedule
double declining balance method, and switching to straight-line depreciation when it is more advantageous. The thr
(200%) when calculating the double declining balance depreciation amount, while the 15- and 20-year schedules us
can be used to construct a MACRS table. Below, we have constructed a MACRS table with all six schedules.
 Equipment Life (Years)
Year 3 5 7
1 33% 20% 14%
2 78% 52% 39%
3 94% 71% 56%
4 Err:502
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21

RWJ Excel Tip

To construct the MACRS table, we used the variable declining balance (VDB) function. Constructing the MACRS table
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 th
zero. Life is the life of the asset. Since we have a table here, we entered the column as a floating input and locked th
further down the table was well as across. The Start_period is the starting period for which we want to calculate the
the year and subtracted 1/2. To calculate the End_period, we used the MIN function. This function will return the le
asset. In most years we could have taken the next year minus one-half, but this would not work for the last year. No
since there is no prior year. So, for the first year, we eliminated the MIN function. Finally, the Factor is not shown on
in this case. We used a factor of two for the three-, five-, seven-, and 10-year schedules and a factor of 1.5 for the 15

Finally, note that the MACRS schedule we calculated can vary slightly from the table presented in the textbook. The
which is the schedule we used in the textbook. However, you are allowed to calculate the schedule on your own bas
get the table above, not the table in the textbook (or the table published by the IRS!). In the future, we will use the t
al application for Excel. When doing a capital budgeting problem, as in most Excel uses, you
lations for you. We will begin with the Baldwin Company project. We have the following

Year 4 Year 5
10,000 6,000

11.5% 11.5%

ear, sales price, and unit costs:

Year 4 Year 5
$ 11,500 $ 11,500
82,700 94,200
17,300 5,800
21.22 21.65
212,242 129,892
13.31 14.64
133,100 87,846

apital for each year minus the net working capital investment at the end of the year. So, the

$ 24,970 $ 21,224
21,224
$ 3,745 $ 21,224
ncerned with the aftertax salvage value, which is:

1), which will be:

$ 212,242 $ 129,892
133,100 87,846
11,500 11,500
$ 67,642 $ 30,546
22,998 10,386
$ 44,643 $ 20,160

s, and IRR for the project are (Table 6.4):

Year 3 Year 4 Year 5

$ 249,696 $ 212,242 $ 129,892
145,200 133,100 87,846
29,001 22,998 10,386
$ 75,495 $ 56,143 $ 31,660
21,772
150,000
(8,650) 3,745 21,224
$ 66,846 $ 59,889 $ 224,656

ear schedules. The MACRS schedule is calculated using the depreciation according to the
when it is more advantageous. The three-, five-, seven-, and 10-year schedules use a factor of 2
hile the 15- and 20-year schedules use a factor of 1.5 (150%). Excel has a function, VDB, which
table with all six schedules.
Equipment Life (Years)
10 15 20
10% 7% 5%
28% 19% 15%
42% 30% 23%

nction. Constructing the MACRS table is tricky because of the half-year convention. Below you
e.
 he answers as a percentage rather than a dollar amount. Salvage is the salvage value, which is
umn as a floating input and locked the row. This allows us to copy and paste the formula
od for which we want to calculate the depreciation. With the half-year convention, we used
nction. This function will return the lesser of the next year minus one-half, or the life of the
s would not work for the last year. Notice that this MIN function will not work for the first year
on. Finally, the Factor is not shown on the picture above since Excel scrolls through the inputs
chedules and a factor of 1.5 for the 15- and 20-year schedules.

table presented in the textbook. The reason is that the IRS publishes a MACRS schedule,
lculate the schedule on your own based on the rules outlined by the IRS. If you do so, you will
e IRS!). In the future, we will use the table in the textbook for our calculations.
 Chapter 6 - Section 3
Inflation and Capital Budgeting

Inflation should always be considered in any long-term project. As long as inflation is correctly handled, the NPV of t
projected proposed by Altshuler, Inc.

Example 6.10: Real and Nominal NPV

Altshuler, Inc. has generated the following forecast for a capital budgeting project. David Altshuler prefers to work i
Whose approach is correct?

Year 0 Year 1 Year 2

Capital expenditures: $ 1,210
Revenues (real terms): $ 1,900 $ 2,000
Cash expenses (real terms): 950 1,000
Depreciation: $605.00 $605.00

Inflation rate: 10.0%

Nominal rate: 15.5%
Real rate: 5.0%
Tax rate: 40.0%

RWJ Excel Tip

To calculate the depreciation each year for straight-line depreciation, we can divide the initial cost by the life of the
as we have done here. The SLN 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 asse
by the life of the equipment in the cell rather than use this particular function, but it is available if you prefer.

With these projections, we can generate the following nominal cash flows and NPV:

Nominal Cash Flows

Year 0 Year 1 Year 2
Capital expenditures $ (1,210)
Revenues $ 2,090 $ 2,420
Expenses 1,045 1,210
Depreciation $605.00 $605.00
Taxable income $ 440 $ 605
Taxes (40%) 176 242
Income after taxes $ 264 $ 363
Depreciation $605.00 $605.00
Cash flow $ 869 $ 968

NPV @ 15.5% $268.00

We can also use real cash flows, which will be:

Real Cash Flows

Year 0 Year 1 Year 2
Capital expenditures $ (1,210)
Revenues $ 1,900 $ 2,000
Expenses $ 950 $ 1,000
Depreciation $ 550 $ 500
Taxable income $ 400 $ 500
Taxes (0%) 160 200
Income after taxes $ 240 $ 300
Depreciation 550 500
Cash flow $ 790 $ 800

NPV @ 5% $268.00

When dealing with any cash flows, it is irrelevant whether you use real cash flows with the real interest rate or nom
value will always be the same.
n is correctly handled, the NPV of the project will be the same. For example, consider the

t. David Altshuler prefers to work in nominal terms, while Stuart Weiss prefers real cash flows.

ide the initial cost by the life of the equipment, or we can use the built-in Excel function SLN
 nd Life, which is the life of the asset. In general, we usually find it easier just to divide the cost
ut it is available if you prefer.

PV:

s with the real interest rate or nominal cash flows with the nominal interest rate, the present
 Chapter 6 - Section 5
Investments of Unequal Lives: The Equivalent Annual Cost Method

To find the equivalent annual cost (EAC), we find the net present value of the project, then find the annuity that rep
Suppose we have two different options for a pollution control system, a filtration system or a precipitation system. T

Filtration Precipitation
system system
Equipment $ 1,100,000 $ 1,900,000
Operating cost $ 60,000 $ 10,000
Life (years) 5 8

Discount rate 12%

Tax rate 34%

We can calculate the NPV of each project as:

Income Statements
Filtration Precipitation
system system
Operating cost $ 60,000 $ 10,000
Depreciation 220,000 237,500
EBIT $ (280,000) $ (247,500)
Tax (95,200) (84,150)
Net income $ (184,800) $ (163,350)

So, using the bottom-up approach, the OCF for each alternative is:

OCF $ 35,200 $ 74,150

Now, we can calculate the NPV of each project:

NPV $ (973,112) $ (1,531,650)

Using the PMT function to find the EAC, we get:

EAC ($269,950.71) ($308,325.40)

In the final analysis, we should choose the system that is the least expensive, which is the filtration system.
Setting a Bid Price: A Capital Budgeting Extension

Suppose the company you work for is entering a competitive bidding process for a new project. How do you determ
for the project? We know that you would not want to lose money on the project from a financial perspective. From
project has a zero NPV, we make exactly the required return on the project. So, the minimum bid price we should su
all of the cash flows of the project such as the initial investment, salvage value, net working capital, etc., we can set
results in a zero NPV. While doing this by hand is possible, it can often result in tedious calculations. Fortunately, Exc
easier.

We are bidding on the following project. The contract will last for four years, and the equipment will be depreciated
bid price we could submit?

Equipment $ 3,300,000
Pretax salvage value $ 75,000
Units per year 125,000
Price per unit $ 22.64
VC as a percentage of sales 45%
Fixed costs $ 425,000
MACRS Year 1 33.30%
MACRS Year 2 44.40%
MACRS Year 3 14.80%
MACRS Year 4 7.40%
Immediate NWC $ 80,000
Tax rate 35%
Required return 10%

We entered a price in the appropriate cell above. As we will show later, it does not really matter what price we ente
the project with our hypothetical price. This will be:

Pro Forma Income Statements

Year 1 2 3 4
Revenues $ 2,830,380 $ 2,830,380 $ 2,830,380 $ 2,830,380
Variable costs 1,273,671 1,273,671 1,273,671 1,273,671
Fixed costs 425,000 425,000 425,000 425,000
Depreciation 1,098,900 1,465,200 488,400 244,200
EBIT $ 32,809 $ (333,491) $ 643,309 $ 887,509
Taxes (35%) 11,483 (116,722) 225,158 310,628
Net income $ 21,326 $ (216,769) $ 418,151 $ 576,881
+ Depreciation 1,098,900 1,465,200 488,400 244,200
OCF $ 1,120,226 $ 1,248,431 $ 906,551 $ 821,081

To find the aftertax salvage value, we need to calculate the taxes. We get:
 Pretax salvage value: $ 75,000.00
Taxes on sale: 26,250.00
Aftertax salvage value: $ 48,750.00

The total cash flows for each year of the project are:

Project Cash Flows

Year 0 1 2 3
OCF $ 1,120,226 $ 1,248,431 $ 906,551
Change in NWC $ (80,000)
Capital spending $ (3,300,000)
Total cash flow $ (3,380,000) $ 1,120,226 $ 1,248,431 $ 906,551

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

NPV: $ -

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

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 save
unexpected internal error or available memory was exhausted" pop up. In this case, the solution is to uninstall Solve

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

ject, then find the annuity that represents the annual cost based on the life of the project.
system or a precipitation system. The relevant numbers for each alternative are:

ch is the filtration system.

a new project. How do you determine the minimum bid price you would be willing to put in
from a financial perspective. From our capital budgeting discussion, we know that if the
he minimum bid price we should submit is the price that results in a zero NPV. Since we know
et working capital, etc., we can set up the cash flows we know and back into the price the
dious calculations. Fortunately, Excel has a built-in function that will make the process much

the equipment will be depreciated on a three-year MACRS schedule. What is the minimum

ot really matter what price we entered. Next, we need to calculate the cash flows and NPV for
 4
$ 821,081
80,000
48,750
$ 949,831

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
he cell we would like to change in order to set the target cell equal to the value we chose. In
d 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 14.0 Answer Report
Worksheet: [CF Chapter 06 Excel Master.xlsx]Section 6.5
Report Created: 10/11/2015 3:41:55 PM
Result: Solver found a solution. All Constraints and optimality conditions are satisfied.
Solver Engine
Engine: GRG Nonlinear
Solution Time: 6.895 Seconds.
Iterations: 1 Subproblems: 0
Solver Options
Max Time 100 sec, Iterations 100, Precision 0.000001
Convergence 0.0001, Population Size 100, Random Seed 0, Derivatives Forward, Require Bounds
Max Subproblems Unlimited, Max Integer Sols Unlimited, Integer Tolerance 5%, Solve Without Integer Constraints

Objective Cell (Value Of)

Cell Name Original Value Final Value
$C$92 NPV: Project Cash Flows $ 333,871.80 $ -

Variable Cells
Cell Name Original Value Final Value Integer
Price per unit Precipitation
$D$48 system $ 25.00 $ 22.64 Contin

Constraints
Cell Name Cell Value Formula Status Slack
$C$92 NPV: Project Cash Flows $ - $C$92=0 Binding 0
ut Integer Constraints
 Chapter 10 - Master It!

For this Master It! assignment, refer to the Goodweek Tires, Inc. case at the end of Chapter 6. For your conven
such as the price, variable cost, etc. on the next page. For this project, answer the following questions:

a. What is the profitability index of the project?

b. What is the IRR of the project?

c. What is the NPV of the project?

d. At what OEM price would Goodweek Tires be indifferent to accepting the project? Assume the replacement m

e. At what level of variable costs per unit would Goodweek Tires be indifferent to accepting the project?
he end of Chapter 6. For your convenience, we have entered the relevant values in the case
swer the following questions:

project? Assume the replacement market price is constant.

ent to accepting the project?

Microsoft Excel 16.0 Answer Report
Worksheet: [CF 11th edition Chapter 06 Excel Master student.xlsx]Solution
Report Created: 2/17/2020 4:49:05 PM
Result: Solver found a solution. All Constraints and optimality conditions are satisfied.
Solver Engine
Engine: GRG Nonlinear
Solution Time: 0.031 Seconds.
Iterations: 1 Subproblems: 0
Solver Options
Max Time 100 sec, Iterations 100, Precision 0.000001
Convergence 0.0001, Population Size 100, Random Seed 0, Derivatives Forward, Require Bounds
Max Subproblems Unlimited, Max Integer Sols Unlimited, Integer Tolerance 5%, Solve Without Integer Constraints

Objective Cell (Value Of)

Cell Name Original Value Final Value
$C$89 NPV Year 0 $12,585,858.45 $0.00

Variable Cells
Cell Name Original Value Final Value Integer
$C$15 Variable cost $ 22 $ 25 Contin

Constraints
Cell Name Cell Value Formula Status Slack
$C$89 NPV Year 0 $0.00 $C$89=0 Binding 0
Integer Constraints
Microsoft Excel 16.0 Answer Report
Worksheet: [CF 11th edition Chapter 06 Excel Master student.xlsx]Solution
Report Created: 2/17/2020 4:55:07 PM
Result: Solver found a solution. All Constraints and optimality conditions are satisfied.
Solver Engine
Engine: GRG Nonlinear
Solution Time: 0.031 Seconds.
Iterations: 1 Subproblems: 0
Solver Options
Max Time 100 sec, Iterations 100, Precision 0.000001
Convergence 0.0001, Population Size 100, Random Seed 0, Derivatives Forward, Require Bounds
Max Subproblems Unlimited, Max Integer Sols Unlimited, Integer Tolerance 5%, Solve Without Integer Constraints

Objective Cell (Value Of)

Cell Name Original Value Final Value
$C$89 NPV Year 0 $12,585,858.45 $0.00

Variable Cells
Cell Name Original Value Final Value Integer
$C$15 Variable cost $ 22 $ 25 Contin

Constraints
Cell Name Cell Value Formula Status Slack
$C$89 NPV Year 0 $0.00 $C$89=0 Binding 0
Integer Constraints
Master It! Solution

Research and development $ 10,000,000

Test marketing cost $ 5,000,000
Initial equipment cost $ 140,000,000
Equipment salvage value $ 54,000,000
Year 1 depreciation 14.30%
Year 2 depreciation 24.50%
Year 3 depreciation 17.50%
Year 4 depreciation 12.50%

OEM market:
Price $ 38
Variable cost $ 22
Automobile production 5,600,000
Growth rate 2.50%
Market share 11.00%

Replacement market:
Price $ 59
Variable cost $ 22
Market sales 14,000,000
Growth rate 2.00%
Market share 8.00%

Price increase above inflation 1%

VC increase above inflation 1%
Marketing and general costs $ 26,000,000
Tax rate 40.00%
Inflation rate 3.25%
Required return 15.90%
Initial NWC $ 9,000,000
NWC percentage of sales 15%

Nominal price increase 4.28%

Nominal VC increase 4.28%

Year 0 Year 1 Year 2 Year 3 Year 4

OEM:
Automobiles sold 5,600,000 5,740,000 5,883,500 6,030,588
Tires for automobiles sold 22,400,000 22,960,000 23,534,000 24,122,350
SuperTread tires sold 2,464,000 2,525,600 2,588,740 2,653,459
Price $ 38.00 $ 39.63 $ 41.32 $ 43.09

Replacement market:
Total tires sold in market 14,000,000 14,280,000 14,565,600 14,856,912
SuperTread tires sold 1,120,000 1,142,400 1,165,248 1,188,553
Price $ 59.00 $ 61.53 $ 64.16 $ 66.91

Revenue:
OEM market $ 93,632,000 $ 100,082,835 $ 106,978,105 $ 114,348,428
Replacement market 66,080,000 70,288,074 74,764,123 79,525,215
Total $ 159,712,000 $ 170,370,909 $ 181,742,228 $ 193,873,643

Variable costs:
OEM market $ 54,208,000 $ 57,942,694 $ 59,391,261 $ 60,876,043
Replacement market 24,640,000 26,209,112 26,733,294 27,267,960
Total $ 78,848,000 $ 84,151,806 $ 86,124,556 $ 88,144,003

Revenue $ 159,712,000 $ 170,370,909 $ 181,742,228 $ 193,873,643

Variable costs 78,848,000 84,151,806 86,124,556 88,144,003
Marketing and general costs 26,000,000 26,845,000 27,717,463 28,618,280
Depreciation 20,020,000 34,300,000 24,500,000 17,500,000
EBT $ 34,844,000 $ 25,074,102 $ 43,400,210 $ 59,611,360
Tax 13,937,600 10,029,641 17,360,084 23,844,544
Net income $ 20,906,400 $ 15,044,461 $ 26,040,126 $ 35,766,816
OCF $ 40,926,400 $ 49,344,461 $ 50,540,126 $ 53,266,816

New working capital:

Beginning 0 $ 9,000,000 $ 23,956,800 $ 25,555,636 $ 27,261,334
Ending 9,000,000 23,956,800 25,555,636 27,261,334
NWC cash flow $ (9,000,000) $ (14,956,800) $ (1,598,836) $ (1,705,698) $ 27,261,334

Book value of equipment $ 140,000,000 $ 119,980,000 $ 85,680,000 $ 61,180,000 $ 43,680,000

Aftertax salvage value:

Market value $ 54,000,000
Taxes (4,128,000)
Total $ 49,872,000

Year 0 Year 1 Year 2 Year 3 Year 4

Operating cash flow $ 40,926,400 $ 49,344,461 $ 50,540,126 $ 53,266,816
Capital spending $ (140,000,000) 49,872,000
Net working capital (9,000,000) (14,956,800) (1,598,836) (1,705,698) 27,261,334
Total cash flows $ (149,000,000) $ 25,969,600 $ 47,745,625 $ 48,834,428 $ 130,400,150

NPV $12,585,858.45
IRR 19.15%
Profitability index 1.0845