SNOW MOUNTAIN CORPORATION

Snow Mountain Corp. (SMC) is considering a new investment to make and sell snow terrain vehicles. The proposed wholesale price to sell to retail stores is $24,000 each. The estimated life of the investment is 6 years. A forecast of unit sales in years 1, 2, 3, 4, 5, and 6 is 30000, 35000, 40000, 40000,20000 and 15000 units respectively. If SMC goes ahead with the snow terrain vehicle investment they will close down their sled divisionthat is forecast to generate $7,000,000 pre-tax cash flow for each of the next 2 years. The cost of the equipment to manufacture the snow terrain vehicles, to be acquired at the beginning, is $300 million. Depreciation of the equipment will use the straight-line depreciation method, 6 year useful life, salvage value of $30 million. The equipment will be installed in anunused SMC plant that has a 5 year (remaining) lease with annual rent of $10,000,000. There is a chance to sublet the vacant plant to another tenant for $4,000,000. SMC does not have any other use for the empty plant. Net working capital is expected to be 30% of incremental annual sales to be invested prior to receiving the revenues. SMC is in the 40% marginal tax rate and currently has a cost of capital of 12%. The snow terrain vehicle investment is considered to be of similar risk to the present risk level of SMC. One-half of the cost of the snow terrain vehicle equipment will be financed with debt at an interest rate of 8%. A marketing study for the snow terrain vehicles segment was completed last month at a cost of $6,000,000 and sent to SMC but has not been fully considered yet. Variable costs are computed to be $10,000 per unit. Fixed costs are figured out at $200 million per annum. The annual inflation rate for the selling price is predicted at 5% whereas the variable cost inflation rate is forecast at 4%.

1. Evaluate the investment using the payback, discounted payback, ARR, NPV, PI, IRR, MIRR and equivalent annual annuity methods.

2. Conduct sensitivity analysis on the NPV to the variables: selling price, variable cost, fixed cost, investment cost, net working capital, and discount rate.

3. If a scenario arises such that the inflation rate for the selling price and variable cost is the same at 7% and sales volume is depressed by 10% for each of the projected years evaluate the investment.

4. If the abandonment value is $100 million at time 5 (year) is this a viable option to take?

5. Should SMC make this investment? Explain.