Case # 2

Baltimore Wiper Blade Company, Inc.

After extensive research and development, Baltimore Wiper Blade Co. (BWB), has developed a new automobile wiper blade, the "Ever Clear" wiper blade and must decide whether to make the investment necessary to produce and market it. The wiper blade 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 $2.5 million.

The Ever Clear would be put on the market beginning this year, and BWB expects it to stay on the market for a total of four years. Test marketing costing $0.5 million and has shown that there is a significant market for Ever Clear blades.

As a financial analyst at BWB, you have been asked by your CFO, Stan Smith, to evaluate the Ever Clear 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.

BWB must initially invest $20 million in production equipment to make the Ever Clear. This equipment can be sold for $3 million at the end of four years. BWB intends to sell the Ever Clear to two distinct markets:

1. The original equipment manufacturer (OEM) market:The OEM market consists primarily of the large automobile companies (like Dodge and Ford) that buy wiper blades for new cars. In the OEM market, the Ever Clear is expected to sell for $12 per set. The variable cost to produce each wiper blade is $5.
2. The replacement market:The replacement market consists of all wiper blades purchased after the automobile has left the factory. This market allows higher margins; BWB expects to sell the Ever Clear for $16 per wiper blade. Variable costs are the same as in the OEM market.

BWB intends to raise prices at 2 percent above the inflation rate; variable costs will also increase at 1 percent above the inflation rate. In addition, the Ever Clear project will incur $10 million in marketing and general administration costs the first year. This cost is expected to increase at the inflation rate in the subsequent years.

BWB corporate tax rate is 30 percent. Annual inflation is expected to remain constant at 3.25 percent. The company uses a 20.0 percent discount rate to evaluate new product decisions.

Automotive industry analysts expect automobile manufacturers to produce 5 million new cars this year and production to grow at 2.0 percent per year thereafter. Each new car needs a set (2) of blades. BWB expects the Ever Clear to capture 15 percent of the OEM market.

Industry analysts estimate that the replacement wiper blade market size will be 15 million blades this year and that it will grow at 2 percent annually. BWB expects the Ever Clear to capture an 8 percent market share.

The appropriate depreciation schedule for the equipment is the seven-year - half year convention, Modified Accelerated Cost Recovery System (MACRS) depreciation schedule. The immediate initial working capital requirement is $3 million. Thereafter, the net working capital requirements will be 15 percent of sales. What are the NPV, payback period, discounted payback period, IRR, and PI on this project?

Hints:

For adjusting price and costs for inflation use Fisher Model:

(1 + R Nominal ) = (1 + r real )(1 + h inflation)

MACRS Depreciation can be found in the text or online

Start by calculating the number of wiper blades sold in each year

Prepare a budget of sales (revenues), costs, EBT, Net Income

Calculate initial Capital outflow

Calculate Operating Cash Flow Change in NWC

Be sure not to forget after tax cash flow of salvage value of equipment in year 4