$10$ points total$)$ Red Pepper is considering expanding beyond its Grand Forks roots to the south

and southeast U$.$S$.$ In valuing this expansion, please consider an explicit forecasting period of

three years $(2016,2017,$ and $2018),$ followed by terminal growth assumptions $(2019$ and

afterward$).$ Below is the relevant information for the valuation:

$$ You are standing at the beginning of $2016.$ All cash flows are assumed to occur at the end of

the relevant year $$ e$.$g$.,2016$ forecasts are for cash flows assumed to occur at the end of $2016.$

$$ Proposal is $50$ new stores.

$$ Each store is expected to have sales of $$2$ million in $2016,$ with cost of goods sold $($COGS$)$

equal to $70\%$ of these sales. Sales and costs will grow at $10\%$ for the first three years $(2016-$

$2018).$

$$ New marketing expenses related to these new stores $($aggregated$)$ is $$10,000,000$ annually for

$2016-2018.$ These costs are expected to be constant from $2016-2018.$

$$ Store build$-$out $($capital expenditures$)$ costs $$5$ million a store, all incurred immediately.

Depreciation will be straight$-$line for $40$ years. $($For the purposes of this problem, see below,

you don$$t have to worry about depreciation in the terminal period.$)$

$$ Red Pepper$$s tax rate is $35\%.$

$$ It plans to finance this expansion with a mix of $30\%$ debt and $70\%$ equity.

$$ Its pretax cost of debt is $6\%,$ which is expected to be the case going forward.

$$ Red Pepper$$s beta is $0\mathrm{.}7,$ assuming a $30\%$ debt to equity mix.

$$ Assume a market risk premium of $5\%,$ and a risk$-$free$-$rate of $4\%.$

$$ During $2019$ and afterward, assume that free cash flows calculated in $2018$ grow perpetually

at $3\%$ per year.

$1)$ For each of years $2016,2017,$ and $2018,$ please provide an estimate of expected revenue

for the Red Pepper expansion. $(1$ point$)$

Year: $201620172018$

Revenue:

$2)$ For each of years $2016,2017,$ and $2018,$ please provide an estimate of expected cost$-$ofgoods$-$sold for the Red Pepper expansion. $(1$ point$)$

Year: $201620172018$

COGS:

$3)$ For each of years $2016,2017,$ and $2018,$ and using the above information as a starting

point, please provide the necessary adjustments and$/$or additional information to calculate

estimates of free$-$cash$-$flow $($FCF$).(1$ point$)$

Year: $201620172018$

FCF:

$4)$ Using the Capital asset pricing model, please calculate Red Pepper$$s cost of equity

capital. $(1$ point$)$

$5)$ Taking into account that Red Pepper will use debt in its capital structure, please calculate

a weighted average cost of capital $($WACC$)$ for Red Pepper related to its new store

expansions. $(1$ point$)$

$6)$ Taking a$-$e into account, and using the WACC you calculated in part $($e$),$ please value the

Red Pepper expansion. Remember that free cash flows in $2019$ are expected to grow at

$3\%$ perpetually. $(1$ point$)$

$7)$ Would the value of the expansion be higher or lower $($circle one for one point$)$ if the riskfree rate increased to $5\mathrm{.}5\%?$ How much so $(1$ point$)?$

$8)$ Suppose that tax laws changed, which allowed Red Pepper to accelerate its depreciation

from $40$ years to $30$ years. Answer each of the following T$/$F statements in this case:

$(3$ points$)$

i$.$ T$/$F $(1$ point$)$ FCF in $2016$ will increase.

ii$.$ T$/$F $(1$ point$)$ This will impact net working capital in $2017.$

iii. T$/$F $(1$ point$)$ The project will become more valuable.