Deluxe Corporation is a large chain of retail stores operating in the USA. It sells top-of therange,

expensive clothes to a wealthy clientele throughout the country. Currently, Deluxe

only operates in the USA. Its current market capitalization is $760 million and the current

market value of debt is $350 million.

At last months management meeting the marketing director explained that sales volume

had increased slightly in the previous year, largely due to heavy discounting in most of its

stores. The finance director expressed concern that such a strategy might damage the

image of the company and reduce profits over the longer term.

An alternative strategy to increase sales volume has recently been proposed by the

marketing department. This would involve introducing a new range of clothing specifically

aimed at the middle-income market. The new range of clothing would be expected to be

attractive to consumers in Canada and Europe.

Assume you (financial analyst) represent the financial management of Deluxe and have

been asked to evaluate the marketing departments proposal to introduce a new range of

clothing. An initial investigation into the potential markets has been undertaken by a firm

of consultants at a cost of $100,000 but this amount has not yet been paid. It is intended

to settle the amount due in three months time. With the help of a small multi-department

team of staff you have estimated the following cash flows for the proposed project:

The initial investment required would be $46 million: This comprises $30 million for

fixed assets and $16million for net current assets (working capital).

For accounting purposes, fixed assets are depreciated on a straight line basis over

three years after allowing for a residual value of 10%.

The value of net current assets at the end of the evaluation period can be assumed to be

the same as at the start of the period.

Earnings before taxes are forecast to be $14million in 2016, $17 million in 2017 and

$22 million in 2018.

The following information is also relevant:

The proposed project is to be evaluated over a three-year time horizon.

Deluxe usually evaluates its investments using an after-tax discount rate of 8%. The

proposed project is considered to be riskier than average and so a risk-adjusted rate of

9% will be used for this project.

Corporate tax is 25%.

Ignore inflation.

Is it worth to do this investment? Explain

Does it create more return? Explain

How will you determine what is your next step? Explain

What is your recommendation?

Show the Excel work.