Problem 4. Valuation (25 points) Company XYZ is considering Introducing a new product line. During the next three years company expects annual sales of $60 million per year for this new line. COGS and operating expenses are expected to be $35 million and $10 million respectively. The product line requires upfront $30 million investment in equipment. The equipment will be obsolete in 3 years (zero residual value) and will be depreciated via the straight-line method over that period. The company expects no changes in net working capital. The risk of the new product line is expected to be the same as the risk of other product lines of XYZ Company. The market value of existing assets of XYZ is $500 million, no extra cash, the market value of debt is $250 million. The debt cost of capital is 6% XYZ current equity holders require 12% XYZ plans to maintain the current debt-to-equity ratio in the future, including any financing related to new product lines. The corporate tax rate is 40%. 4.1. Using WACC approach determine value of the project (without the investment) and the NPV of the project. Will the XYZ Company introduce a new product line? (9 points) 4.2. Show the XYZ market value balance sheet after the undertaking the project for t=0.1.2.3. (Hint: consider the absolute changes in assets and in financing) (4 points) Problem 4. Valuation (25 points) Company XYZ is considering Introducing a new product line. During the next three years company expects annual sales of $60 million per year for this new line. COGS and operating expenses are expected to be $35 million and $10 million respectively. The product line requires upfront $30 million investment in equipment. The equipment will be obsolete in 3 years (zero residual value) and will be depreciated via the straight-line method over that period. The company expects no changes in net working capital. The risk of the new product line is expected to be the same as the risk of other product lines of XYZ Company. The market value of existing assets of XYZ is $500 million, no extra cash, the market value of debt is $250 million. The debt cost of capital is 6% XYZ current equity holders require 12% XYZ plans to maintain the current debt-to-equity ratio in the future, including any financing related to new product lines. The corporate tax rate is 40%. 4.1. Using WACC approach determine value of the project (without the investment) and the NPV of the project. Will the XYZ Company introduce a new product line? (9 points) 4.2. Show the XYZ market value balance sheet after the undertaking the project for t=0.1.2.3. (Hint: consider the absolute changes in assets and in financing) (4 points)
