ABC Tyres, Inc. Proposal Background large-scale company manufacturing tyres in the United States. After extensive research and development, ABC Tyres, Inc., has recently developed a new tyre, the Tread, and must decide whether to make the investment to produce and market it. The be ideal for drivers doing a large amount of wet weather and off road driving in addition to normal freeway usage, The research and development costs so far have totalled SuperTread would be put on the market at the begi nning of next year D. and ABC expects it to stay on the market for a total of four years from Year itoYear Test marketing costin market for a on has s t and shown that there is a signi Super Tread-type tyre. As a Financial Director at ABC Tyres, George Lee has been asked by the Board of directors to evaluate the Super Tread project and provide a recommendation on whether to go ahead He was concerned with the discount rates used in the analysis, as well as with the investment. various comments he had received from other executives at ABC Tyres whom he had asked to review the proposal. Except for the initial investment that will occur immediately (Year 0), assume all cash flows will occur at beginning of year Tyres musi S120 million in production equipment to make the Super Tread in Year o. equipment can be sold for S65. million at the end of four years (Year 4). ABC Tyres intends to sell the SupperTread to two distinct markets. 1) The original equipment manufacturer CoEM) market. The oEM market consists primary of the large automobile companies (like General Motors) that buy Tyres for new cars. In the OEM the SuperTread is expected to sell for $41 per in Year The variable cost to produce each tyre is $18 in Year 1. 2) The replacement market: The replacement market consists of all Tyres purchased after the automobile has left the factory This market allows higher margins; ABC the SuperTread for S62 per tyre there in Year 1. Variables costs Tyres expects to se are the same as in the OEC market. ABC Tyres intends to raise prices at 1 percent above the inflation rate from Year 2 to year 4 in the OEM and the replacement market; variable costs will also increase at percent above the inflation rate from Year 2 to Year 4 as well. In addition, the SuperTread project will incur S25 million in marketing and general administration costs in the first year (Year 1). This cost is expected to increase at the inflation rate in the subsequent years CYear2 to Year 4). ABC Tyres' corporate tax rate is 40 percent. Annual inflation is expected to remain constant at 3.25 percent in next 4 years. Automotive industry analysts expect automobile manufacturers to produce 6.2 million new cars in Year 1 and production will grow at 2.5% per year thereafter. Each new car needs four Tyres (the spare Tyres are undersized and are in different category) ABC Tyres expects the SuperTread to capture 11 percent of the oEM market from year 1 to year 4