Reliant Distribution (RD) is considering expanding into the Southeastern U S adding 40 trucks to its fleet of 125 As the expansion is expected to significantly enhance both revenues and costs, senior management is concerned about the profitability of such a major expansion As a result, you were recently hired to participate on a team under RDs CFO that is responsible for evaluating the cash flows and profitability associated with this specific project (beginning in the summer of 2020) Initially, your team concludes that such a full scale expansion would require an increase in capital expenditures of $148,000,000 In addition, to accommodate increased cash and inventory needs, net working capital requirements are expected to rise by $14,000,000 so the new trucks will be in service and operationally functional The firm expects that 80 of the increase in net working capital will be returned at the projects termination The capital equipment is to be depreciated using a 7 year Modified Accelerated Cost Recovery System (MACRS) schedule Not knowing what the future holds, your team also concludes that this expansion will exist for 7 years thereby finishing in the summer of 2027 Adjustments to the companys operating cash flows are expected to begin in July of 2020 when the trucks are deemed fully operationally functional Also, the capital equipment is expected to have a market value of $13,500,000 at the projects termination Last, your team makes the following assumptions regarding marginal increases in sales and costs for RD 11,000,000 more units will be distributed in years 1 2, at an average sales price of $9 50 per unit, while 12,000,000 more units will be distributed in years 3, 4 5, at an average sales price of $10 50 per unit and 13,000,000 more units will be distributed in years 6 7, at an average sales price of $11 00 per unit Total operating costs (both fixed and variable) are anticipated to be 65 of sales in years 1 2, 55 of sales in years 3 4, and 5, and 45 of sales in year 6 7 RDs marginal tax rate is 24 (used in deriving Operating Cash Flows) and capital gains tax rate is 15 when deriving tax loss gain in salvage value Last, you assume that RD will raise all of the capital to finance this project using a blend of debt and equity and intends to use the same capital structure to raise the funds for this expansion As a result, you base your cost of capital assumptions on the following The firm currently has 440 bonds outstanding with the following terms Remaining Maturity 8 years, Coupon Rate 6 78 (semiannual pay), Current Price $1032 The firm currently has 23,000 common shares outstanding with the following price and market terms Stock price $44 Beta 1 10 Rf Rate 3 ERm 7 The firm currently has 8000 preferred shares currently priced at $88 and has a $3 80 annual fixed dividend If you were to do the same analysis with a range of sales projections, whereas total operating costs (both fixed and variable) are anticipated to be 55 of sales in years 1 2, 45 of sales in years 3 4, and 5, and 35 of sales in year 6 7and the other assumptions hold, what would your NPV and IRR results be

The Answer is in the image, click to view ...

Answered step by step

Verified Expert Solution

Link Copied!

Question

1 Approved Answer

Posted on Sep 29, 2024

Reliant Distribution (RD) is considering expanding into the Southeastern U.S.adding 40 trucks to its fleet of 125. As the expansion is expected to significantly enhance

Reliant Distribution (RD) is considering expanding into the Southeastern U.S.adding 40 trucks to its fleet of 125. As the expansion is expected to significantly enhance both revenues and costs, senior management is concerned about the profitability of such a major expansion. As a result, you were recently hired to participate on a team under RDs CFO that is responsible for evaluating the cash flows and profitability associated with this specific project (beginning in the summer of 2020).

Initially, your team concludes that such a full-scale expansion would require an increase in capital expenditures of $148,000,000. In addition, to accommodate increased cash and inventory needs, net working capital requirements are expected to rise by $14,000,000 so the new trucks will be in service and operationally functional. The firm expects that 80% of the increase in net working capital will be returned at the projects termination. The capital equipment is to be depreciated using a 7-year Modified Accelerated Cost Recovery System (MACRS) schedule. Not knowing what the future holds, your team also concludes that this expansion will exist for 7 years thereby finishing in the summer of 2027.

Adjustments to the companys operating cash flows are expected to begin in July of 2020 when the trucks are deemed fully operationally functional. Also, the capital equipment is expected to have a market value of $13,500,000 at the projects termination.

Last, your team makes the following assumptions regarding marginal increases in sales and costs for RD:

11,000,000 more units will be distributed in years 1 & 2, at an average sales price of $9.50 per unit, while12,000,000more units will be distributed in years 3, 4 & 5, at an average sales price of $10.50 per unit and13,000,000 more units will be distributed in years 6 & 7, at an average sales price of $11.00 per unit.
Total operating costs (both fixed and variable) are anticipated to be 65% of sales in years 1 & 2, 55% of sales in years 3 & 4, and 5, and 45% of sales in year 6 & 7.
RDs marginal tax rate is 24% (used in deriving Operating Cash Flows) and capital gains tax rate is 15%when deriving tax loss/gain in salvage value.

Last, you assume that RD will raise all of the capital to finance this project using a blend of debt and equity and intends to use the same capital structure to raise the funds for this expansion. As a result, you base your cost of capital assumptions on the following.

The firm currently has 440 bonds outstanding with the following terms:
- Remaining Maturity = 8 years, Coupon Rate = 6.78% (semiannual pay), Current Price = $1032.
The firm currently has 23,000 common shares outstanding with the following price and market terms:
- Stock price = $44; Beta = 1.10; Rf Rate = 3%; ERm = 7%
The firm currently has 8000 preferred shares currently priced at $88 and has a $3.80 annual fixed dividend.

If you were to do the same analysis with a range of sales projections, whereas total operating costs (both fixed and variable) are anticipated to be 55% of sales in years 1 & 2, 45% of sales in years 3 & 4, and 5, and 35% of sales in year 6 & 7and the other assumptions hold, what would your NPV and IRR results be?