Microsoft Word - 02 Sp16 BUS-F301 Case Study 2 - Description and RequirementsMicrosoft Word - 02 Sp16 BUS-F301 Case Study 2 - Description and Requirements

Richmond Truck, Inc. is a manufacturer of trucks. Its current line of trucks are selling excellently. However, in order to cope with the foreseeable competition with other similar trucks, RT spent $1,550,000 to develop a new line of deluxe trucks that are more spacious. In addition, the deluxe truck will have built-in GPS and backup camera. The deluxe model is more fuel efficient and has higher MPG than the current model. The company had also spent a further $450,000 to study the marketability of this new model.

HT is able to produce the new model at a variable cost of $9,750 each. The total fixed costs for the operation are expected to be $3,850,000 per year. HT expects to sell 25,000 trucks, 30,000 trucks, 20,000 trucks, 18,000 trucks and 13,000 trucks of the new deluxe model per year over the next five years respectively. They will be selling at a price of $22,000 each. To launch this new line of production, HT needs to invest $550,000,000 in equipment which will be depreciated on a seven- year MACRS schedule. The value of the used equipment is expected to be worth $8,950,000 as at the end of the 5 year project life.

HT is planning to stop producing the existing model entirely in two years. Should HT not introduce the new deluxe model, sales per year of the existing model will be 18,000 trucks and 15,000 trucks for the next two years respectively. The existing model can be produced at variable costs of $8,260 each and total fixed costs of $2,450,000 per year. They are selling for $19,500 each. If HT produces the new deluxe model, sales of the existing model will be eroded by 4,000 trucks for next year and 8,000 trucks for the year after next. In addition, to promote sales of the existing model alongside with the new deluxe model, HT has to reduce the price of the existing model to $15,000 each. Net working capital for the new deluxe model will be 20 percent of sales and will vary with the occurrence of the cash flows. As such, there will be no initial NWC required. The first change in NWC is expected to occur in year 1 according to the sales of the year. HT is currently in the tax bracket of 35 percent and it requires a 15 percent returns on all of its projects.

You have just been hired by HT as a financial consultant to advise them on this new deluxe truck project. You are expected to provide answers to the following questions to their management by their next meeting which is scheduled sometime next month.

1. What is the PI (profitability index) of the project? (10 points)