Flannigans Fish Flies manufactures fishing lures used in the sport of fly-fishing. Flannigans uses an automated process for manufacturing the fishing lures and as a result they are able to produce a lure similar to those made by hand but at a substantially lower cost. This cost savings is then passed on to the customer in the form of lower prices whereas Flannigans sells its lures for $50 each while hand-made lures made by its competitors sell for between $75 and $100. This price differential has resulted in FFF having a strong position in the market with annual sales of 2,100,000 units. However, this number represents the maximum number the firm can sell given the present production capacity of its fly-tying machines. There is currently excess demand for its Flannigans lures and Flannigans is confident that if they could produce an additional 400,000 lures each year they could indeed sell them at the current price of $50 per unit. As such, Flannigans is considering purchasing another fly-tying machine. Two machines are presently being considered that have the production capacity. The first machine, the Fly Deluxe II is a newer version of the Fly Deluxe which is the current equipment the firm uses. It has a purchase price of $9,575,000. The machine would require an additional $69,000 to be shipped to Flannigans manufacturing facility and $56,000 to be installed. The new machine is equivalent in terms of efficiency and operation to the existing equipment. To that extent the current per unit variable costs for producing the lures with the Fly Deluxe II is expected to remain at $39.00 each. If the firm buys the Fly Deluxe II machine the firm will need to hire four additional workers to run it with each being paid $80,000 annually, including benefits. Maintenance expense on the new Fly Deluxe II machine is expected to be $135,000 annually. The firm expects that the Fly Deluxe II will have a useful life of 5 years after which time the firm expects it could salvage the machine to a used parts firm for $500,000. The second machine the firm is considering is much more automated and is called the Fly Star. It has a purchase price of $12,340,000. The machine would require an additional $86,000 to be shipped to Flannigans manufacturing facility and $74,000 to be installed. As the new machine is more automated the firm would only have to hire three additional workers but since they must be more much skilled their salaries will be $95,000 per worker per year. The variable cost for producing the lures with the Fly Star is, however, lower at $36.50 per unit. Maintenance expense on the new machine is expected to be higher at $250,000 annually given its higher level of automation. The firm expects that the Fly Star will have a useful life of 5 years and that after the fifth year Flannigan%u2019s expects it could salvage the machine to a used parts supplier for $925,000. Both new machines fall under the MACRS five year property class. Regardless of which machine the firm uses, since production will be increased the firm will need to increase working capital during the lifetime of their usage by $160,000. The firms marginal tax rate is expected to remain at 40% for the duration of the usage of each machine. Capital Structure Currently, FFFs capital structure is comprised of both long-term debt in the form of bonds and also common stock. Bonds FFF has outstanding 80,000 bonds each having a par value of $1,000. These bonds mature in 16 years and have an annual coupon rate of 7.5% with semi-annual coupon payments. Currently the bonds are trading at 58% of par. Common Stock FFF has outstanding 7,000,000 shares of common stock. The shares are currently trading at $15.00 per share.

FFFs shares paid a dividend of $1.80 per share last year and the dividend is expected to grow at a rate of is 5% this year and forever.

THE PROBLEM Given the information:

1. Determine the Initial Cash Outflow, the Interim Year Incremental Cash Flows, and the Terminal Year Incremental Cash Flows for both Fly Deluxe II and Fly Star.

2. Determine Flanningans current weighted average cost of capital (WACC) given the firms current capital structure.

3. Based upon youre the information in (1) and (2) calculate the Payback Period, the Net Present Value, the Profitability Index, and the Internal Rate of Return for the Fly Deluxe II and the Fly Star given the firms current WACC.

4. Given the calculations in (3), which, if any, of the projects are acceptable? Which project(s) should it choose and why?