Barbara Chan, graduated with an MFA in fashion design and started a successful clothing and accessories design company, Asia Style. Recently, Barbara set to work developing a series of fashion handbags. She has worked out the details for the production and sales of this new venture. By her estimates, she has spent $25,000 on research and samples. Barbara expects an A-year life span for this particular product line project and plans on evaluating the project on that basis (A = 5 + remainder of the division of the last two digits of your student ID divided by 3).

In order to start the project, Barbara plans to set up the projects new operation in a land the company already owns, which was acquired three years ago for $1.2 million and which can be sold today for $1 million dollars.

In addition to the land, the project requires computer driven cutting and assembly machines for the major work. The cost of the machines would be $1.15 million dollars. Shipping and installation would run $18,000 x B ((B = 1 + remainder of the division of the last two digits of your student ID divided by 8). This machine would be fully depreciated on a straight-line basis over the next 10 years for tax purposes. At the end of the A-year project, the machinery can be sold for $400,000.

Based on the analysis of the market research, Barbara believes the bag can be sold at a price of $35.00 per unit in the first year of launch. Then, the price should rise with inflation, currently estimated to be 3%. Barbara thinks sales could start around 50,000 units in the first year. From year 2 onward, the unit sales are expected to grow at a rate of 15% per year.

The project take 1 man-hours to make each bag at a cost of $6.00 per hour. Shipping would cost $1,500 per 1,000 bags. Raw material costs would run $11.10 per bag and fixed overhead cost should be $15,000 per year. Labor costs have been rising 4% per year; whereas raw material and overhead costs are expected to rise with inflation, 3%.

The company would need working capital equal to 8% of the coming years sales at all times. The tax rate for the company is of 35%.

Relevant information to estimate the discount rate (cost of capital) is as follow:

• The beta of Asia Style is 1.C (C = the last digit of your student ID). The risk free rate is 3.5% and the expected return on the market is 11%. Asia Style has 50 million common stock outstanding that are selling for $35 each in the market. The book value of common equity for Asia Style is $1,500 million.
• Asia Style has bond outstanding. The coupon is paid half yearly at the rate of 8%. Bond with similar characteristics are yielding at 6% p.a. The market value of bonds is $300 million.
• Asia Style has 400,000 shares of the preferred stock which pay dividend $9.6 forever which currently sells for $80 per share on the stock market.
• The project is believed to have the same risk as firms typical project

Requirements:

1. Calculate the discount rate (WACC) of the project (20 pts)

(Note: if you cannot answer this question, assume that the discount rate is 15%)

2. Calculate the net present value (NPV) and the internal rate of return (IRR) of the project (50 pts)
3. Should Asia Style proceed the project and why? (10 pts)