Ross, Westerfield, Jordan, and Roberts' Spreadsheet Master

Fundamentals of Corporate Finance, 8th Canadian edition

by Brad Jordan and Joe Smolira
Version 10.0

Chapter 10
In these spreadsheets, you will learn how to use the following Excel fun

Naming cells
SLN
VDB
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 10 - 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 a
should do few or no calculations on your own, but rather let Excel do the calculations for you. We will begin with the
projections for the project:

Cans sold per year: 50,000

Price per can: $ 4.00
Variable cost per can: $ 2.50
Required return: 20%
Fixed costs per year: $ 12,000
Manufacturing equipment: $ 90,000
Project life (years): 3
Initial net working capital: $ 20,000
Tax rate: 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 fo
left of the Formula bar in the name bar and you will see the name "Units." We entered the name in the name bar to
the input from this cell later, we can type in the name of the variable instead of referencing the cell. For example, if y
that the formula we used in this cell is Units * Price_per_unit. When naming cells, you should keep the names short
spaces in 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 $ 200,000
Variable costs 125,000
Fixed costs 12,000
Depreciation 30,000
EBIT $ 33,000
Taxes (34%) 11,220
Net income $ 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 the
SLN 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
the cost by the life of the equipment in the cell rather than use this particular function, but it is available if you prefe

To calculate the AAR, we need the average investment in assets each year. The total investment each year will be:

Year
0 1 2 3
Net working capital $ 20,000 $ 20,000 $ 20,000 $ 20,000
Net fixed assets 90,000 60,000 30,000 -
Total investment $ 110,000 $ 80,000 $ 50,000 $ 20,000

So, the average assets are:

Average assets: $ 65,000

Now, we can calculate the operating cash flow each year, which will be:

EBIT $ 33,000
+ Depreciation 30,000
- Taxes 11,220
Operating cash flow $ 51,780

So, the total cash flow for each year of the project will be:

Year
0 1 2 3
Operating cash flow $ 51,780 $ 51,780 $ 51,780
Changes in NWC $ (20,000) $ 20,000
 Capital spending (90,000)
Total project cash flow $ (110,000) $ 51,780 $ 51,780 $ 71,780

Given these cash flows, we can now calculate the NPV, IRR, and AAR of the project, which are:

NPV $ 10,647.69
IRR 25.76%
AAR 33.51%
or Excel. When doing a capital budgeting problem, as in most Excel uses, you
We will begin with the shark attractant project. We have the following

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

cost by the life of the equipment, or we can use the built-in Excel function
h is the life of the asset. In general, we usually find it easier just to divide
s available if you prefer.

nt each year will be:

 Chapter 10 - Section 4
More on Project Cash Flow

In practice, most assets are depreciated on a MACRS schedule for tax purposes. The three-, five-, and seven-year MA

Property Class
Year 3-year 5- year 7-year
1 33.33% 20.00% 14.29%
2 44.45% 32.00% 24.49%
3 14.81% 19.20% 17.49%
4 7.41% 11.52% 12.49%
5 11.52% 8.93%
6 5.76% 8.92%
7 8.93%
8 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
Year percentage Depreciation
1 20.00% $ 2,400.00
2 32.00% 3,840.00
3 19.20% 2,304.00
4 11.52% 1,382.40
5 11.52% 1,382.40
6 5.76% 691.20
100.00% $ 12,000.00

To find the book value of the asset, we subtract depreciation each year from the beginning book value. The book va

Beginning Ending
Year book value Depreciation book value
1 $ 12,000 $ 2,400.00 $ 9,600.00
2 9,600.00 3,840.00 5,760.00
3 5,760.00 2,304.00 3,456.00
4 3,456.00 1,382.40 2,073.60
 5 2,073.60 1,382.40 691.20
6 691.20 691.20 -

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 if
to calculate the taxes on the sale of the asset is (Book value - Market value)(Tax rate). Suppose the pretax salvage val

Pretax salvage value: $ 3,000

Tax rate: 34%

The aftertax salvage value, and therefore net cash flow from selling the asset at the end of the project (Year 6 in this

Pretax salvage value: $ 3,000.00

Taxes on sale: (1,020.00)
Aftertax salvage value: $ 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 separate
are entering the data in rows for each variable, we could enter the data in columns as well. The input information for

Year 1 2 3 4
Units sales 3,000 5,000 6,000 6,500
Price $ 120 $ 120 $ 120 $ 110
NWC to start $ 20,000
NWC % of sales 15%
Variable cost $ 60
Fixed costs $ 25,000
Equipment $ 800,000
MACRS 14.29% 24.49% 17.49% 12.49%
Pretax salvage 20%
Tax rate 34%
Required return 15%

We will calculate the operating cash flow first, which we can calculate as net income plus depreciation. So, the pro fo
year will be:

Pro Forma Income Statements

Year 1 2 3 4
Revenues $ 360,000.00 $ 600,000.00 $ 720,000.00 $ 715,000.00
Variable costs 180,000.00 300,000.00 360,000.00 390,000.00
Fixed costs 25,000.00 25,000.00 25,000.00 25,000.00
Depreciation 114,320.00 195,920.00 139,920.00 99,920.00
EBIT $ 40,680.00 $ 79,080.00 $ 195,080.00 $ 200,080.00
 Taxes (34%) 13,831.20 26,887.20 66,327.20 68,027.20
Net income $ 26,848.80 $ 52,192.80 $ 128,752.80 $ 132,052.80
+ Depreciation 114,320.00 195,920.00 139,920.00 99,920.00
OCF $ 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, d
the equations to calculate the net income during the first year, we simple copied and pasted the year 1 net income c

Next, we will calculate the change in net working capital. One way to do this is to calculate the difference between th
need to remember that the net working capital at the end of the project will be zero. So, the net working capital req

Year 0 1 2 3
Initial NWC $ (20,000) $ 20,000.00 $ 54,000.00 $ 90,000.00
Ending NWC 54,000.00 90,000.00 108,000.00
NWC cash flow $ (20,000) $ (34,000.00) $ (36,000.00) $ (18,000.00)

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

Pretax salvage value: $ 160,000.00

Taxes on sale: (54,400.00)
Aftertax salvage value: $ 105,600.00

So, the total cash flows for each year of the project are:

Project Cash Flows

Year 0 1 2 3
OCF $ 141,168.80 $ 248,112.80 $ 268,672.80
Change in NWC $ (20,000) (34,000.00) (36,000.00) (18,000.00)
Capital spending $ (800,000)
Total cash flow $ (820,000) $ 107,168.80 $ 212,112.80 $ 250,672.80

Finally, the NPV and IRR of the project are:

NPV: $ 65,487.70
IRR: 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 i
double declining balance method, and switching to straight-line depreciation when it is more advantageous. The thr
2 (200%) when calculating the double declining balance depreciation amount, while the 15- and 20-year schedules u
which 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 33.33% 20.00% 14.29%
2 44.44% 32.00% 24.49%
3 14.81% 19.20% 17.49%
4 7.41% 11.52% 12.49%
5 11.52% 8.92%
6 5.76% 8.92%
7 8.92%
8 4.46%
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
you 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 tha
is zero. Life is the life of the asset. Since we have a table here, we entered the column as a floating input and locked
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 les
asset. In most years we could have taken the next year minus one-half, but this would not work for the last year. Noti
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 is slightly different from the table presented in the textbook for the 6th and 8
is that the IRS publishes a MACRS schedule, which is the schedule we used in the textbook. However, you are allowe
rules outlined by the IRS. If you do so, you will get the table above, not the table in the textbook (or the table publish
the textbook for our calculations.
. The three-, five-, and seven-year MACRS schedules are:

fication and the initial cost is:

he beginning book value. The book value of this asset each year will be:
k value, or a tax rebate will be given if the asset is sold for less than book value. An easy way
rate). Suppose the pretax salvage value of the asset and the tax rate are:

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

e want to put all inputs in a separate cell and have Excel handle all the calculations. While we
mns as well. The input information for the MMCC line of power mulching tools is:

5 6 7 8
6,000 5,000 4,000 3,000
$ 110 $ 110 $ 110 $ 110

8.93% 8.93% 8.93% 4.45%

come 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 71,440.00 71,440.00 35,600.00
$ 203,560.00 $ 153,560.00 $ 103,560.00 $ 89,400.00
 69,210.40 52,210.40 35,210.40 30,396.00
$ 134,349.60 $ 101,349.60 $ 68,349.60 $ 59,004.00
71,440.00 71,440.00 71,440.00 35,600.00
$ 205,789.60 $ 172,789.60 $ 139,789.60 $ 94,604.00

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

to calculate the difference between the beginning and ending net working capital. We also
e zero. So, the net working capital requirements each year are:

4 5 6 7 8
$ 108,000.00 $ 107,250.00 $ 99,000.00 $ 82,500.00 $ 66,000.00
107,250.00 99,000.00 82,500.00 66,000.00 -
$ 750.00 $ 8,250.00 $ 16,500.00 $ 16,500.00 $ 66,000.00

Project Cash Flows

4 5 6 7 8
$ 231,972.80 $ 205,789.60 $ 172,789.60 $ 139,789.60 $ 94,604.00
750.00 8,250.00 16,500.00 16,500.00 66,000.00
105,600.00
$ 232,722.80 $ 214,039.60 $ 189,289.60 $ 156,289.60 $ 266,204.00
 ear schedules. The MACRS schedule is calculated using the depreciation according to the
hen it is more advantageous. The three-, five-, seven-, and 10-year schedules use a factor of
while the 15- and 20-year schedules use a factor of 1.5 (150%). Excel has a function, VDB,
MACRS table with all six schedules.

Equipment Life (Years)

10 15 20
10.00% 5.00% 3.75%
18.00% 9.50% 7.22%
14.40% 8.55% 6.68%
11.52% 7.70% 6.18%
9.22% 6.93% 5.71%
7.37% 6.23% 5.28%
6.55% 5.90% 4.89%
6.55% 5.90% 4.52%
6.55% 6.02% 4.46%
6.55% 6.02% 4.46%
3.28% 6.02% 4.46%
6.02% 4.54%
6.02% 4.54%
6.02% 4.54%
6.02% 4.54%
3.01% 4.54%
4.54%
4.54%
4.54%
4.54%
2.27%

nction. Constructing the MACRS table is tricky because of the half-year convention. Below
edule.
 he answers as a percentage rather than a dollar amount. Salvage is the salvage value, which
olumn 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
ction. This function will return the lesser of the next year minus one-half, or the life of the
would not work for the last year. Notice that this MIN function will not work for the first year
n. 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.

nted in the textbook for the 6th and 8th year of the seven-year MACRS schedule. The reason
he textbook. However, you are allowed to calculate the schedule on your own based on the
e in the textbook (or the table published by the IRS!). In the future, we will use the table in
 Chapter 10 - Section 7
Some Special Cases of Discounted Cash Flow Analysis

Setting a Bid Price

In the chapter, when we explained the process for setting a bid price, we assumed that the depreciation was straight
solve the NPV function is much simpler. With MACRS depreciation, even if sales are the same every year, the cash flo
can solve for just about any variable. Suppose we are bidding on the following project. The contract will last for four
three-year MACRS schedule. What is the minimum 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 33.33%
MACRS Year 2 44.44%
MACRS Year 3 14.82%
MACRS Year 4 7.41%
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 enter
for the project with our hypothetical price. This will be:

Pro Forma Income Statements

Year 1 2 3 4
Revenues $ 2,829,542 $ 2,829,542 $ 2,829,542 $ 2,829,542
Variable costs 1,273,294 1,273,294 1,273,294 1,273,294
Fixed costs 425,000 425,000 425,000 425,000
Depreciation 1,099,890 1,466,520 489,060 244,530
EBIT $ 31,358 $ (335,272) $ 642,188 $ 886,718
Taxes (35%) 10,975 (117,345) 224,766 310,351
Net income $ 20,383 $ (217,927) $ 417,422 $ 576,367
+ Depreciation 1,099,890 1,466,520 489,060 244,530
OCF $ 1,120,273 $ 1,248,593 $ 906,482 $ 820,897

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 $ 1,120,273 $ 1,248,593 $ 906,482
Change in NWC $ (80,000)
Capital spending $ (3,300,000)
Total cash flow $ (3,380,000) $ 1,120,273 $ 1,248,593 $ 906,482

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

NPV: $ (0.00)

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 or
this case, we changed the unit price cell. This is why the original value we entered for the unit price is irrelevant: Sol
Note that after we used Solver, we restored the original value. On the next worksheet, you can see the answer repor
results in a 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 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
This is a repeat of Step 1.
4) Check the Solver add-in and select OK.

Example 10.4: Equivalent Annual Cost

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

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.
ed that the depreciation was straight-line. This assumption means that the math required to
are the same every year, the cash flows will be different each year. However, with Excel, we
roject. The contract will last for four years, and the equipment will be depreciated on a

not really matter what price we entered. Next, we need to calculate the cash flows and NPV
 4
$ 820,897
80,000
48,750
$ 949,647

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

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

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

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

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

oject, then find the annuity that represents the annual cost based on the life of the project.
or a precipitation system. The relevant numbers for each alternative are:
hich is the filtration system.
Microsoft Excel 12.0 Answer Report
Worksheet: [Chapter 10.xlsx]Section 10.6
Report Created: 02/19/2012 5:35:12 PM

Target Cell (Value Of)

Cell Name Original Value Final Value
$C$55 NPV: Project Cash Flows $ - $ -

Adjustable Cells
Cell Name Original Value Final Value
$D$11 Price per unit $ 22.64 $ 22.64

Constraints
NONE
 Chapter 10 - Master it!

For this Master It! assignment, refer to the Conch Republic Electronics case at the end of Chapter 10. For your c
the case 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 price would Conch Republic Electronics be indifferent to accepting the project?

e. At what level of variable costs per unit would Conch Republic Electronics be indifferent to accepting the project
 Chapter 10. For your convenience, we have entered the relevant values in
he following questions:

o accepting the project?

Master it! Solution

Equipment $ 21,500,000
Pretax salvage value $ 4,100,000
R&D $ 750,000
Marketing study $ 200,000

Year 1 Year 2 Year 3 Year 4

Sales (units) 74,000 95,000 125,000 105,000
Sales of old PDA 80,000 60,000
Lost sales 15,000 15,000
Depreciation rate 14.29% 24.49% 17.49% 12.49%

Price $ 360
VC $ 155
FC $ 4,700,000
Price of old PDA $ 290
Price reduction
of old PDA $ 35
VC of old PDA $ 120
Tax rate 35%
NWC percentage 20%
Required return 12%

Sales Year 1 Year 2 Year 3 Year 4

New
Lost sales
Lost revenue
Net sales

VC
New
Lost sales
Total VC

Sales
VC
Fixed costs
Dep
EBT
 Tax
NI
+Dep
OCF

NWC
Beg
End
NWC CF

Net CF

Salvage
BV of equipment
Taxes

Salvage CF

Time Cash flow

0
1
2
3
4
5

a. Profitability index

b. IRR

c. NPV

d. Minimum price

e. Maximum VC
Year 5
80,000

8.93%

Year 5