SleepBetter is an American company located in Kirkland, WA. The company specializes in selling sheets, pillowcases and comforter when it was founded in 1931. Over the years, the company still maintains its main business, which accounts for about 50 percent of its total revenue. In 1990, the company entered into the business of manufacturing mattresses due to stiff competition. You and your team, the Carson College of Business graduates, are hired by the company's finance department to evaluate a new project for the company.

SleepBetters only mattress type so far is a traditional inner spring called the Beautyrest, and sales have been excellent. SleepBetters main competitor in the mattresses market is TEMPUR-SEALY International, Inc (TPX). SleepBetters Beautyrest is similar to the TEMPUR-Adapt but is relatively cheaper. This year, however, SleepBetter wants to incorporate a new high-end gel-infused memory foam mattresses, the Kingsdown into their lineup. SleepBetter spent $13,950,000 to develop the new Kingsdown which features extreme comfort, pressure relief, better breathability and air circulation than the existing Beautyrest. The company has spent a further $550,000 for a marketing study to determine the expected sales figures for the new mattresses.

SleepBetter can manufacture the new mattresses for $2,800 per mattress in variable costs. Fixed costs for the operation are estimated to run $30 million per year. The estimated sales volume is 90,870, 96,437, 94,700, 95,432 and 96,000 mattresses per year for the next five years, respectively. The unit price of the new mattress will be $4,499. The necessary equipment can be purchased for $460 million and will be depreciated on a five-year MACRS schedule. It is believed the value of the equipment in five years will be $300 million.

As previously stated, SleepBetter currently manufactures the Beautyrest. Production of the existing product is expecting to be terminated in three years. If SleepBetter does not introduce the new luxury Kingsdown product, sales of the existing product will be 90,000, 89,732 and 88,679 mattresses per year for the next three years, respectively. The price of the existing mattress is $3,000 per mattress, with variable costs of $1,350 each and fixed costs of $28 million per year. If SleepBetter does introduce the new mattress, sales of the existing one will fall by 6,000 mattresses per year, and the price of the existing mattresses will have to be lowered to $2,799 each mattress. Net working capital for the project will be 20 percent of sales and will occur with the timing of the cash flows for the year; for example, there is no initial outlay for NWC, but changes in NWC will first occur in Year 1 with the first year's sales. SleepBetter has a 35 percent corporate tax rate. The company has a target debt to equity ratio of .6 and is currently BB- rated (according to S&P 500 ratings).

The finance department of the company has asked your team to prepare a report to Robert, the companys CEO, and the report should answer the following questions.

1. Robert are also interested in the cost of capital of the mattress industry. Therefore, he asks you to find the cost of equity, the cost of debt, and the WACC of TPX. Please show your computational steps clearly and document data sources used and any assumptions you make.