In this assignment you take the position of an analyst working within a large clothing designer / manufacturer / retailer. Your company has developed an e-ink usable in cloth and it intends to maintain the recipe and production process as a trade secret. This, combined with the somewhat complicated nature of the technology, requires that rather than outsourcing the production of garments including the technology your firm will be required to manufacture them in house. You are tasked with determining which of three potential geographic locations for the new plant best serve the interests of the firm and its stakeholders or if e-ink products should not be brought to market based on revenue and cost projections. In addition there is potential in some locations to move forward with some of the firm's sustainability agenda and source the power from the plant using wind or solar energy.
You estimate that your product will have a six-year life span, and the equipment used to manufacture the project falls into the MACRS 7-year class. The resulting MACRS depreciation percentages for years 1 through 8, respectively, are 14.29%, 24.49%, 17.49%, 12.49%, 8.93%, 8.92%, 8.93%, and 4.46%. Your venture would require a capital investment of $140,000,000 in equipment, plus $10,000,000 in installation costs. The venture will increase accounts receivable and inventories of $35,000,000. At the end of the six-year life span of the venture, you estimate that the equipment could be sold at a $50,000,000 salvage value. Your venture would incur fixed costs of $10,000,000 per year, while the variable costs of the venture would typically equal 30 percent of revenues depending on the location of the plant. You are projecting that revenues generated by the project would equal $40,000,000 in year 1, $150,000,000 in year 2, $180,000,000 in year 3, $160,000,000 in year 4, $110,000,000 in year 5, and $80,000,000 in year 6. The baseline WACC or discount rate is 19.4%, but this may be adjusted depending on the risk of the location.
The following list of steps provides a structure that you should use in analyzing your new venture. Note: Carry all final calculations to two decimal places.
- Determine the marginal tax rate (5 points)
- Compute the Year 0 investment for the Project. (5 points)
- Compute the annual operating cash flows for years 1-6 of the project. (20 points)
- Compute the non-operating (terminal) cash flow at the end of year 6. (10 points)
- Draw a timeline that summarizes all of the cash flows for your venture. (5 points)
- Compute the IRR, payback, discounted payback, and NPV for the Project. (20 points)
- Compute the standard deviation of the NPV of the project (10 points)
- Prepare a report for the firm's CEO indicating which location if any should be accepted and why, including careful explanation of tradeoffs and concerns in non-financial factors. (40 points)
- Assign dollar heuristics to pertinent non-financial factors and determine whether your recommendation in 10. is consistent with heuristics using the NPV criterion.