MicroDryer Enterprises is a company that manufactures microwave dryers. Using microwaves eliminates shrinkage of cotton and wool. The company currently offers a full sized dryer and is considering development of a new product: a countertop microwave dryer that could be used in dorm rooms, apartments, or hotels. The sales and costs estimates for this new venture are provided below:

Expected annual sales in year 1 are 215,000 units and are expected to increase at a rate of 12% a year through year 4, at which point sales will decrease at a rate of 18% a year through year 10. Expected sales price is $250 per unit in todays dollars.

No sales cannibalization is expected to occur.

Expected development costs of the product (at time 0) are $80 million, which will be depreciated over 10 years using straight-line method.

Annual fixed costs of production are $1 million and variable costs of production are estimated to be $100 per unit in todays dollars.

Sale price, fixed and variable costs of production are expected to increase at the rate of 5.5% annually. The tax rate for MicroDryer Enterprises is 34%.

The inventory balance is 25% of revenues, accounts payable are 50% of inventory, and accounts receivables are 10% of revenues.

The expected life of the project is not known, so the company has estimated that cash flows after the tenth year will increase at an annual rate of 3.5%. (Do not recover the NWC at the end of ten years.)

The firms discount rate is 19%. Your task, as a high-flying analyst at MDE, is to value the new product line and advise MDE on the investment.

13) Assume now is the end of 2014. For the first ten years (from now until 2024), complete a pro forma statement (forecast of Free Cash Flow) in Excel spreadsheet. (HINT: The steps required are

i) determine the initial costs for the project in 2014, ii) forecast sales, costs, etc through 2015 2024,

iii) calculate EBIT for the years 2015 2024,

iv) use EBIT to calculate Free Cash Flow.)

14) Calculate the NPV of the new business line. To do this, answer the following:

a) Now estimate the continuing value at the end of year ten. Combine this with the free cash flows from Q13. Be careful about the timing!

b) Calculate the NPV of the new business line. Should MDE go ahead with the project? Explain using one sentence. Note on Excel: Be careful with the NPV function in Excel. The NPV function in Excel uses only future cash flows (cash flows in time 1 and onwards). You must manually adjust by adding the initial (time 0) cash flow.

c) A colleague points out that MDE spent $30 million exploring the viability of this exact product line 2 years ago. He argues that you should include the $30 million as a cost in your valuation. Do you agree? Explain in less than three sentences.

15) Your boss asks you to run a sensitivity analysis. In particular:

a) She is concerned about the continuing value. What happens to the NPV if cash flows only grow at 1.5% after year 10?

b) She is concerned that the project is riskier than MDEs current assets. If the true discount rate is 38% should MDE invest in the new project?