Purpose: To provide specific practice in applying the fundamentals of capital budgeting to a corporate investment decision in a realistic setting. To complete the problem successfully you need to accurately estimate the cash flows for the project from estimates of sales and costs and compute several standard capitalbudgeting criteria including NPV, payback period, discounted payback period, IRR and Profitability Index. Please write up the case in a professional manner. If you do the computations in a spreadsheet (recommended), please include this spreadsheet in your submission, named according to the conventiongiven above. If you do the computations by hand, please include an appendix to your word document showing the steps you took to get to your answers. GWYNT INDUSTRIES, INC. GWYNT Industries is a specialized manufacturing firm. It has been looking for new opportunities to expand its profitability as a manufacturer and has recently been approached to be the sole source contract supplier to a major computer manufacturer of an important computer component (cooling fan). The contract with the computer maker would be guaranteed for four years with no expectation of contract extension. A significant reason for this offer is a new, innovative and particularly reliable manufacturing approach for this component that GWYNT developed after extensive research and development. GWYNT has also researched the market for independent sales of the same component to parts distributors for specialty makers and hobbyists. GWYNT Industries must now decide whether to make the investment necessary to go into the computer cooling fan business. The contract with the major maker would begin this year, and the specialty/hobby market could also begin this year. They could enter either market alone or both markets simultaneously. If GWYNT enters either market, production of the computer fans would use factory space that could be leased to another company for $150,000 per year for the next 4 years. Further, the R&D costs noted above to develop the process have totaled about $175,000, and the marketing research on the specialty/hobby market cost $50,000. The CFO of GWYNT Industries, has asked you, as a financial analyst, to evaluate this new opportunity project and to provide a recommendation on whether to go ahead with the investment that would allow them to enter one or both markets. To simplify the analysis, assume that the initial investment that will occur immediately and all other cash flows will occur at year-end in each year.GWYNT Industries must initially invest $1.8 million to purchase new production equipment for the new product. Some of this cost, $390,000, can be recouped at the end of the project, 4 years from now, by selling the production equipment. As noted above, GWYNT Industries can potentially sell the cooling fans in two distinct markets (the marketsare independent, i.e., GWYNT will be able to see in both markets): 1. Under contract: The contract with the major computer maker calls for 45,000 cooling fan units in the first year at $45 per unit. Thereafter, the number of units delivered will increase by 2% per year and the price received by GWYNT will increase by 2% percent each year until the end of the four-year contract. 2. The specialty/hobbyist market: This retail market has higher margins; GWYNT expects to receive a unit price of $60 in this market in the first year. The market research predicts that the total size of this entire market (i.e., all manufacturers combined) will be 90,000 units in the first year and that GWYNT can obtain a 20% market share of the market, i.e., 20% of units sold. It is expected that unit sales in this entire market will grow by 3% per year, and that GWYNT will be able to maintain its 20% market share and increase its price by 2% each year. The variable costs to produce each unit is $18 in the first year. Since the product in each market is essentially identical, this unit cost is the same for units produced for either market. However it is projected that this cost will increase each year by 5% percent each year because of efficiency losses as the production equipment ages. Further, GWYNT will incur general, marketing and administrative costs of $350,000 the first year. These period costs are expected to be hold constant in the subsequent years. These general marketing and administrative costs will cover their involvement in either market or both markets.GWYNTs marginal corporate tax rate is 34% percent. The company uses a 15% discount rate to evaluate new investment decisions of this kind. The appropriate depreciation schedule for the equipment is the seven-year MACRS depreciation schedule. This allows the following depreciation schedule for the four years of the project: First year 14.3% Second year 24.5% Third year 17.5% Fourth year 12.5% The immediate initial working capital requirement is $200,000. Thereafter, the net working capital requirements will be 11% percent of sales (i.e., required at the end of each year except the last, when working capital is recovered.) You are asked to provide the following items (and the analysis that leads to them): NPV, IRR, payback period, discounted payback period, and profitability index for this project. A recommendation about whether Gwynt should proceed with this project based on your decision rules. Assuming that the contract market sales are guaranteed but the Specialty/Hobbyist market sales are not, provide an estimate of the minimum market share that Gwynt must achieve in the Specialty/Hobbyist market for this overall project to have a positive net present value. (Advice: Start by writing down a list of all the relevant facts. Get the year 0 costs (immediate costs) and the analysis for year 1 correct (and plausible) before projecting years 2, 3 and 4. Make each year a column in a spreadsheet. Pay attention to things that happen at the end of the project. These things show up in year 4.)

(Hints: As described, this project has a positive net present value so if you do not find a positive NPV, you have probably made a mistake. If Gwynts share of the specialty/hobbyist market turns out to be zero, the total project would have a negative NPV i.e., Gwynt would not do this project for the contract market alone. Gwynt would also not do this project for the specialty/hobbyist market alone because the project would have a negative NPV. Thus, when you build your income statement analysis, consider the sum of the revenues from both markets and the sum of the costs from both markets. Also include any revenue that would be lost if this project is adopted. You could look at the contract market alone by simply setting the Specialty/Hobbyist market share to zero. You could look at the Specialty/Hobbyist market alone by setting unit sales in the contract market to zero) Gwynt is a large company with other sources of income. Thus any losses that might occur, either year-to-year or on the sale of an asset, will generate cash flows from tax savings due to lower taxes.