Prudence

Rodriguez was still contemplating the 2013 Sneaker project when she began reviewing another proposal for a new hiking shoe being considered. The hiking shoe would be named Prudence. The hiking and active walking sector was one of the fastest growing areas of the footwear industry and one they had not yet entered. She was confident that hiking shoes would be the newest footwear trend in the coming decade. The target market for this shoe would be men and women in the 25-to 40-year-old age category.

The business case for the hiking shoe needed some work; but after preliminary analysis, she focused on the following information:

1. The life of the Prudence project would be only three years, given the steep technological learning curve for this new product line.

2. The wholesale price of Prudence (net to Bew Nalance) would be $90.00.

3. The hiking segment of the athletic shoe market was projected to reach $350 million during 2013, and it was growing at a rate of 15% per year. Bew Nalance’s market share projections for Prudence were: 2013, 15%; 2014, 18%; and 2015, 20%.

4. The firm would be able to use an idle section of one of its factories to produce the hiking shoe. A cost accountant estimated that, according to the square footage in the factory, this section’s overhead allocation would amount to $1.8 million per year. The firm would still incur these costs if the product were not undertaken. In addition, this section would remain idle for the life of the project if the Prudence project were not undertaken.

5. The firm must purchase manufacturing equipment costing $8 million. The equipment fell into the five-year MACRS depreciation category. Depreciation percentages for the first three years respectively were: 20%, 32%, and 19%. The cash outlay would be at Time 0, and depreciation would start in 2013. Analysts estimated the equipment could be sold for book value at the end of the project’s life.

6. Inventory and accounts receivable would increase by $25 million at Time 0 and would be recovered at the end of the project (2015). The accounts payable balance was projected to increase by $10 million at Time 0 and would also be recovered at the end of the project.

7. Because the firm had not yet entered the hiking shoe market, introduction of this product was not expected to impact sales of the firm’s other shoe lines.

8. Variable costs of producing the shoe were expected to be 38% of the shoe's sales.

9. General and administrative expenses for Prudence would be 12% of revenue in 2013. This would drop to 10% in 2014 and 8% in 2015.

10. The product would not have a celebrity endorser. Advertising and promotion costs would initially be $3 million in 2013, then $2 million in both 2014 and 2015.

11. The company's federal plus state marginal tax rate was 40%.

12. In order to begin immediate production of Prudence, the design technology and the manufacturing specifications for a new hiking shoe would be purchased from an outside source for $50 million. This outlay was to take place immediately and be expensed immediately for tax purposes.

13. Annual interest costs on the debt for this project would be $600,000. In addition, Rodriguez estimated the cost of capital for the hiking shoe would be 14%.

1. Produce a projected capital budgeting cash flow statement for the Prudence project by answering the following:

a. What is the project’s initial (year 0) investment outlay?

b. What are the project’s annual (years 2013-2018) net operating cash flows?

c. What is the project’s terminal (2018) non-operating net cash flow?

d. Does Prudence appear viable from a quantitative standpoint? To answer this question, estimate the project’s payback, net present value, and internal rate of return.