Intermediate Corporate Finance $-$ Fin $304$

LazxMan Inc.

Part I. Cash Flow Estimation and Capital Budgeting Criteria

The LazyMan Company is evaluating the market potential of a newly designed reclining armchair aimed at the "boomer bubble." The results of an initial questionnaire that LazxMan has conducted in major markets six months ago and cost $\backslash (\backslash$$ $65,000\backslash )$ were positive. A more comprehensive market test study that will cost an additional $\backslash (\backslash$$ $220,000\backslash )$ was just completed and affirmed at least a $\backslash (15\backslash \%\backslash )$ of the total reclining chair market. LazyMan has not yet paid for this study.

Now LazyMan is at the point where it is considering investing in the assets needed to produce the reclining chairs. The chairs would be produced in a building owned by the firm. The building, which was bought by LazyMan $25$ years ago for $\backslash (\backslash$$ $200,000\backslash ),$ is currently vacant but it can be sold for $\backslash (\backslash$$ $850,000\backslash ).$ The value of the building on LazyMan's books is $\backslash (\backslash$$ $72,000\backslash ).$ LazyMan can depreciate this $\backslash (\backslash$$ $72,000\backslash )$ over three years on a straight$-$line basis. In order to estimate the market value of the building at project's end, the company assumes that the price change will follow the trend experienced in the last $25$ years. The land on which the building sits was bought for $\backslash (\backslash$$ $80,000\backslash )$ twenty five years ago and it is valued at $\backslash (\backslash$$ $270,000\backslash )$ today. The expected appreciation in the land value is $\backslash (5\mathrm{.}50\backslash \%\backslash )$ per year over the coming ten$-$year period. LazyMan assumes that it will be able to sell both the building and the land together at their expected values at the end of the project's life.

The price of the new equipment needed is $\backslash (\backslash$$ $43,600,000\backslash ).$ It will require and additional $\backslash (\backslash$$ $400,000\backslash )$ in shipping and installation costs. The useful life of the equipment is $16$ years but the company intends to use it for only the ten years that is the life of the project and then sell it at the termination of the project. It estimates its salvage value at $\backslash (\backslash$$ $22,000,000\backslash ).$ Production is estimated to be $24,200$ units in the first year, rising by $\backslash (18\backslash \%\backslash )$ per year for the following six years then falling by $\backslash (6\mathrm{.}00\backslash \%\backslash )$ per year for the remaining life of the project. The price of the chairs in the first year will be $\backslash (\backslash$$ $1,350\backslash ).$ The reclining chair market is highly competitive and LazyMan believes that the price will only increase by $\backslash (3\mathrm{.}00\backslash \%\backslash )$ per year. However, the wood, plastic, and other ingredients used to produce the chairs are rapidly becoming more expensive. Variable production costs estimated at $\backslash (\backslash$$ $715\backslash )$ per unit in the first year will rise by $\backslash (12\mathrm{.}00\backslash \%\backslash )$ per year for the following five years then by $\backslash (7\mathrm{.}00\backslash \%\backslash )$ per year for the following four years. Total fixed costs excluding depreciation expense is assumed to stay constant at $\backslash (\backslash$$ $2,220,000\backslash )$ per year for the life of the project. In addition, LazyMan is aware of the fact that some of the demand for its new chairs will be the result of shifting demand from its sales of the existing models. It estimates that the new production will replace $5,350$ units per year that bring in an after$-$tax EBIT of $\backslash (\backslash$$ $640\backslash )$ per unit. The marginal tax rate applicable to this project is $\backslash (24\backslash \%\backslash ).$

LazyMan anticipates that it will maintain an investment in working capital equal to $\backslash (\backslash$$ $280,000\backslash )$ initially $($at time point zero$)$ and rising by $\backslash (5\mathrm{.}00\backslash \%\backslash )$ per year in the first six years then declining by $\backslash (17\mathrm{.}00\backslash \%\backslash )$ in each of years seven, eight, and nine before is completely recovered in year ten. LazyMan uses the straight$-$line depreciation for all its depreciable assets.

A$)$ On an Excel spreadsheet, estimate the following:

$1.$ Initial cash flow outlay or Initial net investment $($NINV$)($show it clearly in one box$)$

$2.$ After$-$tax salvage value $($ATSV$)$ for each of the relevant assets and the sum of all ATSVs $($clearly show details for all salvageable assets in their own box$)3.$ The annual depreciation schedule

$4.$ The schedule for the annual incremental investment in NWC

$5.$ The annual free cash flows $($FCF$).$ Show all details in an income statement format.

At this point in the project, assume that the required rate of return on LazyMan's project of similar risk is $\backslash (14\backslash \%\backslash ).$

B$)$ Use the capital budgeting decision criteria to decide which ones point to acceptance of the new project. Show in as much detail as possible on an Excel spreadsheet how you will evaluate the project including all estimates of cash flows and all the necessary calculations. Assume LazyMan uses a required payback of $6$ years or less.

C$)$ LazyMan is not always comfortable with the estimate of its cost of capital so it uses a sensitivity analysis to check how robust its project valuations to various estimates of cost of capital. The estimate should start with $\backslash (0\backslash \%\backslash )$ and increase by increments of $\backslash (5\backslash \%\backslash )$ points until it reaches $\backslash (30\backslash \%\backslash ).$ For each estimate an NPV is calculated to analyze the sensitivity of NPV to various discount rate assumptions. Plot the NPV profile $($NPV on y$-$axis and discount rates on x $-$axis$).$ Watch where the NPV curve intersects with the $\backslash ($ x $\backslash )-$axis. What do you call the intersection point $($make sure that point is shown in the NPV table$)?$

Spreadsheet is due as an Excel file $($printed in Landscape on one page width an