GOODWEEK TIRES, INC. After extensive research and development, Goodweek Tires, Inc., has recently developed a new tire, the Super Tread, and must decide whether to make the investment necessary to produce and market it. The tire 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 $10 million. The Super Tread would be put on the market beginning this year, and Goodweek expects it to stay on the market for a total of four years. Test marketing costing $5 million has shown that there is a significant market for a SuperTreadtype tire. As a financial analyst at Goodweek Tires, you have been asked by your CFO, Adam Smith, to eval- uate the Super Tread project and provide a recommendation on whether to go ahead with the invest- ment. Except for the initial investment that will occur immediately, assume all cash flows will occur at year-end. Goodweek must initially invest $120 million in production equipment to make the SuperTread. This equipment can be sold for $51 million at the end of four years. Goodweek intends to sell the SuperTread to two distinct markets: 1. The Original Equipment Manufacturer (OEM)Market The OEM market consists primar- ily of the large automobile companies (e.g., General Motors) who buy tires for new cars. In the OEM market, the Super Tread is expected to sell for $36 per tire. The variable cost to produce each tire is $18. 2. The Replacement Market The replacement market consists of all tires purchased after the automobile has left the factory. This market allows higher margins and Goodweek expects to sell the Super Tread for $59 per tire there. Variable costs are the same as in the OEM market iloodweek fires intends to ruse prices at I percent above Me inflation rate; variable costs will also Increase 1 percent above the inflation rate. In addition, the Super [read project will incur $25 million in marketing and general administration costs the first year. This cost is expected to increase at the inflation rate in the subsequent years. Goodweek's corporate tax rate is 40 percent. Annual inflation is expected to remain constant at 3.25 percent. The company uses a 15.9 percent discount rate to evaluate new product decisions Automotive industry analysts expect automobile manufacturers to produce 2 million new cars this year and production to grow at 2.5 percent per year thereafter. Each new car needs four tires (the spare tires are undersized and are in a different category). Goodweek Tires expects the SuperTread to capture 11 percent of the OEM market. Industry analysts estimate that the replacement tire market size will be 14 million tires this year and that it will grow at 2 percent annually. Goodweek expects the Super Tread to capture an 8 percent market share. The appropriate depreciation schedule for the equipment is the seven-year MACRS depreciation schedule. The immediate initial working capital requirement is $11 million. Thereafter, the networking capital requirements will be 15 percent of sales. What are the NPV, payback period, discounted pay- back period, AAR. IRE, and Pl on this project? Input area: $ $ $ $ Research and development Test marketing cost Initial equipment cost Equipment salvage value Year 1 depreciation Year 2 depreciation Year 3 depreciation Year 4 depreciation 10,000,000 Sunk Cost - excluded from Cash Flow 5,000,000 Sunk Cost - excluded from Cash Flow 160,000,000 65,000,000 Comoute Each Year Depreciation 14.30% 5 22,880,000.00 24.50% 5 39,200,000.00 17.50% $ 28,000,000.00 12.50% 5 20,000,000.00 $ OEM market: Price Variable cost Automobile production Growth rate Market share 41 29 6,200,000 2.50% 11.00% $ $ Replacement market: Price Variable cost Market size Growth rate Market share 62 29 32,000,000 2.00% 8.00% Price increase above inflation VC increase above inflation Marketing and general costs $ Tax rate Inflation rate Required return Initial NWC $ NWC percentage of sales 1% 1% 43,000,000 40.00% 3.25% 13.40% 9,000,000 15% Output area: Output area: Nominal price increase Nominal VC increase 4.28% Computed for you 4.28% Computed for you Year o Year 1 Year 2 Year 3 Year 4 OEM: Automobiles sold Tires for automobiles sold SuperTread tires sold Price per Tire 6,200,000 24,800,000 2,728,000 41.00 $ 6,355,000 25,420,000 2,796,200 42.76 s 6,513,875 26,055,500 2,866,105 44.59 $ 6,676,722 26,706,888 2,937,758 46.50 Computed for you Computed for you Computed for you Computed for you $ Replacement market: Total tires sold in market SuperTread tires sold Price per Tire Revenue: OEM market Replacement market Total Variable costs: VC per Tire Total VC in OEM market Tot VC in Replacement market Total (43,000,000) (44,397,500) (45,840,419) (47,330,232) Computed for you Revenue Variable costs Marketing and general costs Depreciation EBT Tax Net income OCF New working capital: Beginning Ending NWC cash flow Values inputed for Values inputed for you 0 S 9,000,000 9,000,000 $ (9,000,000) $ 9,000,000 $ Computed for you Book value of equipment $ 160,000,000 Aftertax salvage value: Market value Taxes Total Year o Year 1 Year 2 Year 3 Year 4 Operating cash flow Capital spending NWC Cash flow Total cash flows NPV IRR Profitability index GOODWEEK TIRES, INC. After extensive research and development, Goodweek Tires, Inc., has recently developed a new tire, the Super Tread, and must decide whether to make the investment necessary to produce and market it. The tire 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 $10 million. The Super Tread would be put on the market beginning this year, and Goodweek expects it to stay on the market for a total of four years. Test marketing costing $5 million has shown that there is a significant market for a SuperTreadtype tire. As a financial analyst at Goodweek Tires, you have been asked by your CFO, Adam Smith, to eval- uate the Super Tread project and provide a recommendation on whether to go ahead with the invest- ment. Except for the initial investment that will occur immediately, assume all cash flows will occur at year-end. Goodweek must initially invest $120 million in production equipment to make the SuperTread. This equipment can be sold for $51 million at the end of four years. Goodweek intends to sell the SuperTread to two distinct markets: 1. The Original Equipment Manufacturer (OEM)Market The OEM market consists primar- ily of the large automobile companies (e.g., General Motors) who buy tires for new cars. In the OEM market, the Super Tread is expected to sell for $36 per tire. The variable cost to produce each tire is $18. 2. The Replacement Market The replacement market consists of all tires purchased after the automobile has left the factory. This market allows higher margins and Goodweek expects to sell the Super Tread for $59 per tire there. Variable costs are the same as in the OEM market iloodweek fires intends to ruse prices at I percent above Me inflation rate; variable costs will also Increase 1 percent above the inflation rate. In addition, the Super [read project will incur $25 million in marketing and general administration costs the first year. This cost is expected to increase at the inflation rate in the subsequent years. Goodweek's corporate tax rate is 40 percent. Annual inflation is expected to remain constant at 3.25 percent. The company uses a 15.9 percent discount rate to evaluate new product decisions Automotive industry analysts expect automobile manufacturers to produce 2 million new cars this year and production to grow at 2.5 percent per year thereafter. Each new car needs four tires (the spare tires are undersized and are in a different category). Goodweek Tires expects the SuperTread to capture 11 percent of the OEM market. Industry analysts estimate that the replacement tire market size will be 14 million tires this year and that it will grow at 2 percent annually. Goodweek expects the Super Tread to capture an 8 percent market share. The appropriate depreciation schedule for the equipment is the seven-year MACRS depreciation schedule. The immediate initial working capital requirement is $11 million. Thereafter, the networking capital requirements will be 15 percent of sales. What are the NPV, payback period, discounted pay- back period, AAR. IRE, and Pl on this project? Input area: $ $ $ $ Research and development Test marketing cost Initial equipment cost Equipment salvage value Year 1 depreciation Year 2 depreciation Year 3 depreciation Year 4 depreciation 10,000,000 Sunk Cost - excluded from Cash Flow 5,000,000 Sunk Cost - excluded from Cash Flow 160,000,000 65,000,000 Comoute Each Year Depreciation 14.30% 5 22,880,000.00 24.50% 5 39,200,000.00 17.50% $ 28,000,000.00 12.50% 5 20,000,000.00 $ OEM market: Price Variable cost Automobile production Growth rate Market share 41 29 6,200,000 2.50% 11.00% $ $ Replacement market: Price Variable cost Market size Growth rate Market share 62 29 32,000,000 2.00% 8.00% Price increase above inflation VC increase above inflation Marketing and general costs $ Tax rate Inflation rate Required return Initial NWC $ NWC percentage of sales 1% 1% 43,000,000 40.00% 3.25% 13.40% 9,000,000 15% Output area: Output area: Nominal price increase Nominal VC increase 4.28% Computed for you 4.28% Computed for you Year o Year 1 Year 2 Year 3 Year 4 OEM: Automobiles sold Tires for automobiles sold SuperTread tires sold Price per Tire 6,200,000 24,800,000 2,728,000 41.00 $ 6,355,000 25,420,000 2,796,200 42.76 s 6,513,875 26,055,500 2,866,105 44.59 $ 6,676,722 26,706,888 2,937,758 46.50 Computed for you Computed for you Computed for you Computed for you $ Replacement market: Total tires sold in market SuperTread tires sold Price per Tire Revenue: OEM market Replacement market Total Variable costs: VC per Tire Total VC in OEM market Tot VC in Replacement market Total (43,000,000) (44,397,500) (45,840,419) (47,330,232) Computed for you Revenue Variable costs Marketing and general costs Depreciation EBT Tax Net income OCF New working capital: Beginning Ending NWC cash flow Values inputed for Values inputed for you 0 S 9,000,000 9,000,000 $ (9,000,000) $ 9,000,000 $ Computed for you Book value of equipment $ 160,000,000 Aftertax salvage value: Market value Taxes Total Year o Year 1 Year 2 Year 3 Year 4 Operating cash flow Capital spending NWC Cash flow Total cash flows NPV IRR Profitability index