Case study

You have just been hired by Intel in its finance division. Your first assignment is to determine

the net cash flows and NPV of a proposed new generation of mobile chips.

Capital expenditures to produce the new chips will initially require an investment of

$1.2 billion. The R&D that will be required to finish the chips is $500 million this year.

Any ongoing R&D for upgrades will be covered in the margin calculation in 2a below.

The product family is expected to have a life of five years. First-year revenues for the new

chip are expected to be $2,000,000,000 ($2,000 million). The chip family’s revenues are

expected to grow by 20% for the second year, and then decrease by 10% for the third,

decrease by 20% for the 4th and finally decrease by 50% for the 5th (final) year of sales.

Your job is to determine the rest of the cash flows associated with this project. Your boss

has indicated that the operating costs and net working capital requirements are similar

to the rest of the company’s products. Since your boss hasn’t been much help, here are

some tips to guide your analysis:

1. Obtain Intel’s financial statements. Download the annual income statements and

balance sheets for the last four fiscal years from Wall Street Journal Website

(https://www.wsj.com/market-data/quotes/INTC/financials/annual/incomestatement).

Go to “Financials.” Click “Annual,” to ensure you’re getting

annual, instead of quarterly, data. Next, copy and paste the income statements

and balance sheets into Excel.

2. You are now ready to determine the free cash flow. Compute the free cash flow for

each year using Eq. 9.6 from this chapter showing all steps :

Free Cash Flow =

$++++++++++%++++++++++& Unlevered Net Income

(Revenues - Costs - Depreciation) * (1 - Tax Rate)

+ Depreciation - CapEx - Change in NWC

CASE STUDY

Set up the timeline and computation of the free cash flow in separate, contiguous

columns for each year of the project life. Be sure to make outflows negative and

inflows positive.

a. Assume that the project’s profitability will be similar to Intel’s existing projects

in 2015 and estimate costs each year by using the 2015 ratio of non-depreciation

costs to revenue:

[(Cost of Revenue + SG&A + R&D)/ Total Revenue]

You should assume that this ratio will hold for this project as well. You do not need

to break out the individual components of operating costs in your forecast. Simply

forecast the total of Cost of Revenue + SG&A + R&D for each year.

b. Determine the annual depreciation by assuming Intel depreciates these assets by

the straight-line method over a 5-year life.

c. Determine Intel’s tax rate as [1 - (Income After Tax/Income Before Tax)] in 2015.

Note that on Intel’s income statement on Google Finance, there is a difference

between operating income and income before tax. That difference is due to small

adjustments. Ignore this issue and simply focus on the Income Before Tax line.

d. Calculate the net working capital required each year by assuming that the level

of NWC will be a constant percentage of the project’s sales. Use Intel’s 2015

NWC/Sales to estimate the required percentage. (Use only accounts receivable,

accounts payable, and inventory to measure working capital. Other components of

current assets and liabilities are harder to interpret and are not necessarily reflective

of the project’s required NWC—e.g., Intel’s cash holdings.)

e. To determine the free cash flow, calculate the additional capital investment and

the change in net working capital each year.

3. Determine the IRR of the project and the NPV of the project at a cost of capital

of 12% using the Excel functions. For the calculation of NPV, include

cash flows 1 through 5 in the NPV function and then subtract the initial cost

(i.e., = NPV1rate, CF1 CF5 2 + CF0 2. For IRR, include cash flows 0 through 5 in

the cash flow range