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3. You must analyze a potential new producta caulking compound that Cory Materials R&D people developed for use in the residential construction industry. Corys marketing

3.

You must analyze a potential new producta caulking compound that Cory Materials R&D people

developed for use in the residential construction industry. Corys marketing manager thinks they

can sell 115,000 tube per year at a price of $3.25 per year for 3 years, after which the product will

be obsolete. The required equipment would cost $150,000, plus another $25,000 for shipping and

installation. Current assets would increase by $35,000 while current liabilities would rise by

$15,000. Variable costs would be 60% of sales revenues, fixed costs (excluding depreciation)

would be $70,000 per year, and fixed assets would be depreciated under MACRS with a 3-year life.

The relative depreciation rates would be 33.33%, 44.44%, 14.82% and 7.41%. When production

ceases after 3 years, the equipment will have a market value of $15,000. Corys tax rate is 40%

and it uses a 10% wacc for average-risk projects.

a.

Calculate the projects NPV, IRR, MIRR, PI, payback and discounted payback.

b.

Suppose you learn that R&D costs for the new product were $30,000 and that those costs

were incurred and expensed for tax purposes last year. How would this affect your

estimate of NPV and the other profitability measures?

c.

If the new project would reduce cash flows from Corys other projects and if the new project

would be housed in an empty building that Cory owns and could sell, how would those

factors affect he projectsNPV?

d.

Are this projects likely to be positively or negatively correlated with returns on Corys

other projects and with the economy, and should this matter in your analysis? Explain.

e.

The CEO expressed concern that some of the base-case inputs for the caulking compound

might be too optimistic or too pessimistic, and he wants to know how the NPV would be

affected if these six variables were 20% better or 20% worse than the base-case

levels: unit sales, sales price, variable costs, fixed costs, wacc, and equipment cost. Hold other

things constant when you consider each variable and construct a sensitivity graph to

illustrate your results.

f.

Do a scenario analysis on the assumption that there is a 25% probability that each of the six

variables itemized in part (e) will turn out to have their best-case values as calculated in

Part (e), a 50% chance probability that all will have their base-case values, and a 25%

probabililty that willhave their worst-case values. The other variables remain at base-case

levels. Calculate the expected NPV, the standard deviation of NPV, and the coefficient of

variation.

g.

Based on the risk analysis, make a recommendation to Cory Materials regarding the caulking compound.

h.

Unrelated to the new product, Cory is analyzing two mutually exclusive machines that will

upgrade its manufacturing plant. These machines are considered average-risk projects, so

management will evaluate them at the firms 10% wacc. Machine X has a life of 4 years,

while Machine Y has a life of 2 years. The cost of each machine is $60,000; however,

Machine X provides after-tax cash flows of $25,000 per year for 4 years and Machine Y

provides after-tax cash flows of $42,000 per year for 2 years. The manufacturing plant is

very successful, so the machines will be repurchased at the end of each machines useful

life. In other words, the machines are repeatable projects. Using the replacement chain

method, what is the NPV of the better machine? Using the Equivalent Annual Annuity

method, what is the EAA of each machine?

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