Toyland Toys is a midsized Toy manufacturer located in Omaha, Nebraska. The company president is Sandra Willowbrook, who inherited the company. When it was founded over 100 years ago, the company originally was a gift shop. Over the years, the company still maintains its main retail business, which expanded into a chain gift shop and accounts for about 50 percent of its total revenue. The company also expanded into the business of manufacturing toys. You and your team, the Carson College of Business graduates, are hired by the company's finance department to evaluate a new project for the company. One of the major revenue-producing items of Toyland Toys's manufacture division is a Baby Doll. Toyland Toys currently has one baby doll, and sales have been excellent. Toyland Toys's main competitor on the baby doll market is Mattel Inc (MAT), a leading toy manufacturing company with headquarters in El Segundo, California. Toyland Toys's baby doll is a unique item in that it comes in a variety of hair styles and is preprogrammed to play Lady Gaga music. However, Toyland wants to incorporate new technology into their products. Toyland Toys spent $750,000 to develop a prototype for a new baby doll that has all the features of the existing baby doll but adds new features such as an AI system, much like Apples Siri or Amazons Echo, but for children. The company has spent a further $200,000 for a marketing study to determine the expected sales figures for the new baby doll. Toyland Toys can manufacture the new baby dolls for $20 each in variable costs. Fixed costs for the operation are estimated to run $2.1 million per year. The estimated sales volume is 145,000, 195,000, 112,500, 79,500, and 47,500 per year for the next five years, respectively. The unit price of the new baby doll will be $95. The necessary equipment can be purchased for $24 million and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $7.1 million. As previously stated, Toyland Toys currently manufactures a baby doll. Production of the existing model is expected to be terminated in two years. If Toyland Toys does not introduce the 2 new baby doll, sales will be 80,000 units and 60,000 units for the next two years, respectively. The price of the existing baby doll is $65 per unit, with variable costs of $17 each and fixed costs of $1.3 million per year. If Toyland Toys does introduce the new baby doll, sales of the existing baby doll will fall by 5,000 units per year, and the price of the existing units will have to be lowered to $40 each. Net working capital for the baby dolls will be 20 percent of sales and will occur with the timing of the cash flows for the year; for example, there is no initial outlay for NWC, but changes in NWC will first occur in Year 1 with the first year's sales. Toyland Toys has a 35 percent corporate tax rate. The company has a target debt to equity ratio of .5 and is currently BBB rated. The overall cost of capital of the company is 10 percent. The finance department of the company has asked your team to prepare a report to Sandra, the company’s president, and the report should answer the following questions.

QUESTIONS 1. Can you and your team prepare the income statement table, the operating cash flow (OCF) table, and the total cash flow from assets (CFFA) table?

2. Can you use these tables to help explain to Sandra the relevant incremental cash flows of this project?

3. Peter, a newly graduated MBA in the company’s finance department suggested that you should use 10% as the discount rate for the discounted cash flow (DCF) analyses for this new project.

a. Do you and your team agree with him Can you explain why?

b. If your team don’t agree with Perter, please find the cost of capital for this project and explain in details to Sandra, the president, how your team comes up with this cost of capital for this project?

4. What are the NPV and IRR of the project 5. Should Sandra take the new project? Why or why not?