CanTech Inc.

Background

CanTech Inc.is a Canadian multinational company, privately owned, that specializes in design and manufacturing of complete digital transmission systems as well as individual components for digital audio and video broadcasting. The company has been in business since 1990 and was trading on the Toronto Stock Exchange until 2003, when management bought the manufacturing and technology development assets and created a privately held company known today as CanTech Inc. Inspired by strong demand for its products and in anticipation of rising sales of digital broadcasting equipment, CanTech Inc. vigorously expanded its global presence by establishing subsidiaries in some of the most promising markets around the world. Presently, CanTech Beijing, CanTech America, and CanTech Europe are all controlled by CanTech Inc. and constitute an integral part of the firms corporate strategy, directed at supporting CanTech Inc. international clients and promoting its products and services abroad. While CanTech Inc.has a very comprehensive and highly competitive product line, which continuously expands, the primary focus has always been on customization of design and production to address the specific needs of its clients in the following sectors: Broadcast Instrumentation & Scientific Equipment Military (TACAN) / Radar SATCOM The focus of the company is on the following areas: GaN / GaAs / LDMOS - based high power indoor and outdoor amplifier systems, phase combined to achieve power level up to 10 KW. Solid state amplifier modules Satellite/ Terrestrial SFN & MFN Solution Adaptive pre-correction for power amplifier linearization Digital Modulation solution for all key international standards (Including DVB T/H, DVB SH, DVB T2, DVB S2, DAB, DTMB. CMMB, ISDB-T, ISDBT-TB and ATSC) Passives components including waveguide (Including flex), Couplers filters and other coaxial parts Military RF and Calibration equipment (TACAN (IFF) and UHF Amplifier) Mobile digital television and radio broadcasting equipment. Amplifiers CanTech Inc.is widely recognized and has a reputation for designing, developing, and manufacturing solid-state high-power amplifiers that are critically important for satellite, industrial, scientific, and medical applications. CanTech had developed a proprietary technology to manufacture broadband and band-specific solid-state power amplifiers and the demand has steadily increased over the years due to increase in mobile communications and satellite deployments. However, the maintenance costs have increased significantly in the last period. The amplifiers are designed to work in extreme conditions and the repairs and maintenance are done, most of the time, remotely. If one component of the amplifier malfunctions, it is critical to fix it immediately; otherwise the issue could cascade and trigger the failure of all other components. Usually, the clients detect and report the problems with the amplifiers very late in the process making the repair extremely costly. Also this has a significant negative impact on the customer satisfaction.

The Project

To overcome this problem, CanTechs management decided to launch a new device that will be installed inside the amplifiers to continuously monitor and stream data related to the functioning performance of all components. In this way, issues related to different components will be identified and fixed soon after they occur without the client involvement. Moreover, this device will provide statistics related to the quality of components and their behavior in different environments allowing CanTech to optimize the product quality for the clients specific needs. At the same time by manufacturing this new device, CanTech has the opportunity to expand the scope of the project beyond internal need as other manufacturers of equipment might face the same issues. After conducting a market research, CanTechs management expects that the new device can be sold externally with minimum adjustments. CanTech decided to set up a separate department with the exclusive mandate of designing, launching, manufacturing and marketing the new device internally and externally. This new department would be an investment center. You as a CanTechs controller have to determine if the project is feasible based on the following estimations provided by the management; the life of the project is 10 years: The new division will generate revenue from two streams: internal orders for amplifiers and external clients. CanTechs management estimates that internal sales will be 8,500 units in the first year and it will increase between 3% and 11% per year the following years. After internal analysis and discussions, the transfer price of the new device was set up to equal the variable cost plus 15%. An analyst hired by CanTech estimates that the new division will be able to sell 7500 units in the first year to external clients and it expects a subsequent increase between 3% to 12% year over year. This estimation is based on a selling price of $330. The standard usage of materials for the new device is 1.7 meters of copper cable, one chip of $55, and other raw materials totaling $22. It customary for Torus, to purchase copper cables only in large rolls of 315 meters at a price of $1,134 per roll. Assembly workers are paid at an hourly rate of $35 and testers at a rate of $60 per hour. The company policy is to increase salaries with the inflation rate plus 1%. It is estimated that the inflation rate will be constant in the foreseeable future at 2% per year. The standard labor required for the device is 2.7 hours for assembly and 0.5 for testing. The overhead costs will be $250,000 in the first year and expected to increase at a rate of 1% per year. Working Capital needed is $300,000, which will be recovered fully at the end of the project. To promote the new device to external clients, CanTech will spend an estimated $125,000 per year. Every 2 years an additional $80,000 is required for software development and deployment. The first software upgrade is expected to take place in year 3.

Depreciation Total investment in the project is estimated at $4,500,000 from which 25% will be invested in software development (no salvage value) Class 10, CCA rate 30%, and the remaining amount will be used to acquire a new assembly line (Class 8, CCA rate 20%), the assembly line has a salvage value estimated at 18% of the original price.

WACC

CanTech has another $2,000,000 bank loan with an effective interest rate of 6%; $5,000,000, 8%, 15-year bonds selling at 75% of face value; $3,500,000 of 8%, $10 noncumulative, non-callable preferred stock with a total market value of $2,440,000; 100,000 shares of $10 par common stock, with a total current market value of $5,500,000. The estimated required rate of return on the common stock, based on application of the CAPM, is 15%. Other The firm is subject to a 35% income tax rate, and it uses 10% discount rate.

Requirements

1. Calculate the WACC