Fanning Analytics manufactures a variety of electronic products. The company is considering introducing its most exciting product; a new digital instrument panel for customized classic cars. This panel allows the car owner to customize the complete set of instruments for the vehicle. Output display may be analog or digital, with many styles of display using apps that may be purchased, downloaded, and installed with a micro SD card. Your analysts have provided you with the following forecast information for the Fully Customizable Instrument Panel (FCIP):

The project has an anticipated economic life of 3 years.

The company will have to purchase a new machine to produce the detergent. The machine has an up-front cost (t = 0) of $2,468,000.

The equipment will be depreciated using the MACRS method using the year conventionwith a 3 year class life:

t = 1 33.33%

t = 2 44.45

t = 3 14.81

t = 4 7.41

At the end of the project, the expected value (salvage value) of the equipment is $225,500.

If the company goes ahead with the proposed product, it will have an effect on the companys net operating working capital. At the outset, t = 0, inventory will increase by $275,000 and accounts payable will increase by $23,925. At t = 3, the net operating working capital will be recovered after the project is completed.

The detergent is expected to generate incremental sales revenue as follows:

Year 1: $3.275 million

Year 2: 3.750 million

Year 3: 2.950 million

(After the third year, the project will no longer provide any additional incremental sales.)

The operating costs, excluding depreciation, are expected to be 62% of the annual sales.

The new detergent is expected to reduce the after-tax cash flows of the companys otherexisting products by $158,000 a year (t = 1, 2, and 3).

The companys tax rate is 40 percent.

Fanning considers this to be a higher risk project.

The before tax cost of debt (rd) for Fanning is 6.10%, and the common stock beta is 1.15. The current capital structure (market value) is as follows:

Fanning, Ind.

Debt $166,667

Equity 833,333

$1,000,000

Fanning uses the firms WACC for average risk projects, it adds 2% for high risk projects. For low risk projects it uses the WACC less 2%.

Your analysts also compiled current market information:

Market risk premium (RPm): 4.00%

Risk-free rate (rRF): 2.50%

Given the above information: (Show your work and calculations)

1. a. (5 points) What is Fanning's cost of equity (rs)?

b. (5 points) What is the firm's cost of capital (WACC)?

c. (5 points) Define Hurdle Rate.

d. (3 points) What is the appropriate hurdle rate for evaluating this project?

(Enter the correct answer)

e. (3 points) If a company uses the same discount rate for evaluating all projects, which of the following results is likely? __________________

Accepting poor, high-risk projects.

Rejecting good, low-risk projects.

Accepting only good, low-risk projects.

Accepting no projects.

Answers a and b are correct.

f. (3 points) Which of the following constitutes an example of a cost which is notincremental, and therefore not relevant in an accept/reject decision? ________________

A firm has a parcel of land that can be used for a new plant site or, alternatively, can be used to grow watermelons.

A firm can produce a new cleaning product that will generate new sales, but some of the new sales will be from customers who switch from another product the company currently produces.

A firm orders and receives a piece of new equipment which is shipped across the country and requires $25,000 in installation and set-up costs.

All of the above are not examples of incremental cash flows.

Answers a, b, and c are examples of incremental cash flows, and therefore, relevant cash flows.