Monsanto Inc. is considering a 4-year project involving the production and sale of a new corn seed that will produce plants that are more highly resistant to many common pests. The firm has already spent $12M on research and development efforts.1 To proceed with the project, Monsanto would need to spend another $8M on administrative, advertising, and training costs, and another $15M on production equipment.2Marketing personnel estimate sales revenue of $20M, $40M, $25 and $15M over the life of the project. Accounting and Operations have forecasted expense levels. They anticipate that the project will require annual fixed expenses of $3M and annual variable expenses equal to 30% of sales revenue. Monsantos corporate tax rate is 30%, and it expects to raise $20M of the projects necessary investment capital by issuing bonds. These bonds will generate an annual interest expense of $2M.Because of fluctuations that may occur in demand levels, Monsanto will need to carry an inventory of seed during the project. Operations and cost-accounting personnel feel that the inventory should be kept at 30% of the next years projected sales. Monsanto anticipates that the new, more resistant corn seed will reduce after-tax cash flows gained from its current seed product by 0.5 M a year. Monsanto expects that 25% of its annual sales will be in accounts receivable at the end of each year, and 10% of its annual expenses will be in payables as well. This project has a predicted stand-alone risk of 0.44. The overall market portfolio is believed to have an expected risk and return of 0.16 and 0.13, respectively. The new project is much like many current Monsanto projects and the average correlation between sales levels and the stock market has been about 0.25. The current risk free rate in the economy is 0.04. The project will be financed using 70% debt and 30% equity.

Footnotes: 1 Part of these previous expenditures were used to build a testing facility. The facility has a net salvage value of $2.65M and it will serve as part of the production facilities if the project is accepted. Some prototype production machinery has also purchased. It currently has a net salvage value of $1.5M and will be sold regardless of whether the project is pursued or not. 2 The equipment would be depreciated using a 5-year MACRS schedule (20%, 32%, 19%, 12%, 11%, 6% are the factors) and it is expected to have a market salvage value of $3M at the end of the project.