3a. (50 pts) Meadows Memories (MM), a world-class photography company, is considering diversifying through the acquisition of equipment from another company, Arvin Enterprises (AE), a private company that manufactures cute little big-eyed stuffed animals. The plan is to purchase the equipment and re-evaluate the stuffed

animal manufacturing project after 5 years. MM paid $10,000 to a research company for significant

due-diligence to gather information regarding the potential acquisition of AE. Based upon this preliminary

acquisition due-diligence, the following AE-specific information has been made available to you:

AE expects the life of the stuffed animals is 5 years and they expect sales next year to be 20,000 units and grow at 4% per year. The sale price of each stuffed animal should be $16 for the first 3 years, then $11 in years 4 and 5 as cabbage patch dolls are expected to become stylish again. Each stuffed animal costs $5 per unit in variable costs and fixed costs should be about $65,000 each year.

The equipment used to manufacture the dolls is believed to be worth $350,000 now and will be fully depreciated (using straight-line method) at the end of the 5 years. However, AE had planned to spend $50,000 in repairs and upgrades on the machinery in year 3 to increase efficiency. Additionally, AE stated they need $150,000 in working capital now (to keep up with demand) and expect to need an additional $25,000 each year through year 4, all of which will be recovered at the end of the life of the project. There is no expected salvage value of the equipment.

MM's marginal tax rate is 30%.

Based on the above information, calculate the expected annual Free Cash Flows for the stuffed animal project from AE.

3. (50 pts) In addition to the information given in the Meadow's Memories problem (part 3a), the following general and MM-specific information has been made available to you:

MM currently has 8.2% coupon, $1,000 par value bonds that pay semi-annual interest and will mature in 25 years that are currently going for $925 in the market.

Additionally, MM's common stock just paid a $0.55 dividend which they expect to grow at 5.1% per year. Their stock beta is currently 1.4.

MM's current market value capital structure is 50% long-term debt, and 50% common stock (MM has no preferred stock outstanding and plans to never issue any). You also know that MM's target debt weight of their capital structure (for the foreseeable future) is 65%.

MM has a 5-year max threshold for project payback. You also know that 10-year Treasury bonds are currently at 3.3%, and the current S&P 500 rate of return is 14.4%.

Based on the information given above:

A. Calculate MM's Weighted Average Cost of Capital (WACC).

B. Calculate the Payback, IRR, MIRR, NPV and PI of the purchase of AE's equipment using MM's WACC. Based on these numbers, should the project be undertaken? (You will have to copy/reference your Free Cash Flow estimates from part 3 to this tab to complete this part.)