After extensive research and development, Hankook Tires, Inc., has recently developed a new tire, the SuperTread, and must decide whether to make the investment necessary to produce and market it. The tire would 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 totaled about $10 million. The SuperTread will be put on the market beginning this year, and Hankook expects it to stay on the market for a total of four years. Test marketing costing $5 million has shown that there is a significant market for a SuperTread-type tire.

As a financial analyst at Hankook Tires, you have been asked by your CFO, Paul Craig, to evaluate the SuperTread project and provide a recommendation on whether to go ahead with the investment. Except for the initial investment that will occur immediately, assume all cash flows will occur at year-end.

Hankook must initially invest $160 million in production equipment to make the SuperTread and the firm will use straight line depreciation. This equipment can be sold for $65 million at the end of four years. The immediate initial working capital requirement is $9 million. Thereafter, the net working capital requirements will be 15 percent of sales every year.

Hankook intends to sell the SuperTread to two distinct markets:

1. The original equipment manufacturer (OEM) market: The OEM market consists primarily of the large automobile companies (like General Motors) that buy tires for new cars. The following table has the projected sales and associated operating costs for the OEM market.

OEM Market	Year 1	Year 2	Year 3	Year 4
Revenues ($ millions)	111.848	119.5166	127.7109	136.4671
Operating Costs ($ millions)	79.112	84.53612	90.33212	96.52552

2. The replacement market: The replacement market consists of all tires purchased after the automobile has left the factory. This market allows higher margins. The following table has the projected sales and associated operating costs for the Replacement market.

Replacement Market	Year 1	Year 2	Year 3	Year 4
Revenues ($ millions)	158.72	168.7749	179.4668	190.836
Operating Costs ($ millions)	74.24	78.9431	83.94415	89.26201

In addition, the SuperTread project will incur the following marketing and general administration costs:

	Year 1	Year 2	Year 3	Year 4
Marketing and Gen. Admin Costs ($ Millions)	43	44.3975	45.84042	47.33023

Hankook's corporate tax rate is 21 percent. The company uses a 17.5 percent discount rate to evaluate new product decisions.

Questions:

1. What cashflows is this project expected to generate? This section will be graded as follows:

Prepare a balance sheet i.e., investment section and in your analysis pay attention to how you treat:

o Capital expenditure for the new production equipment.

o Changes in NWC

o The research and development costs

o Test marketing costing

Prepare an income statement for the life of the project and estimate the net income for each year.

Finally, estimate the operating cash flows and free cashflows of the project.

2. Calculate the profitability index (PI), net present value (NPV), and internal rate of return (IRR) for the project. Should Hankook Tires undertake this project, why?

3. How high does the discount rate on this project have to be for the project to start having a negative NPV?