Street Performance Industries (SPI) is considering a new product for vehicle owners to assist them in the maintenance of their cars. This product provides owners the status of all conditions monitored by the vehicles electronic control modules so that they may have the information to assist them as they work with their dealer or maintenance shop to maintain and repair their car/truck. This device is expected to result in significant savings for the owner through early detection of problems and will serve as a second opinion about repairs needed on the car. It will also have features that allow owners to refine the tuning of the vehicle for either performance or for fuel economy. This will include the adjustment to the tuning of the engine and transmission to optimize performance for towing.

The actual product consists of a Bluetooth device that plugs into the vehicles diagnostic connector (used by the dealer and service center), which connects to an app on your phone. The app can connect both to the vehicle and to the Street Performance analytics center that maintains date for the vehicle.

Car Tech Evaluation Expert (CTEX) (This is the preliminary code name during development). This product is designed for vehicles built since the mid 1990s that have the OBD2 diagnostics system (and newer), up to vehicle that are 3 or 4 years old, (It takes a period of time to develop databases on the new vehicles).

Market studies indicate that CTEX may be valuable to any vehicle owner that wants another layer of evaluation in addition to the dealer and repair center, and especially to an enthusiast. The company analyst interns have also provided the following forecasts for the project.

Initial investment:

o SPI has found a site and will purchase the equipment to support the project. This equipment is to produce the Bluetooth device the servers for data storage and analytics. The equipment, including shipping and installation is expected to cost (t=0) $ 9,250,000.

o The investment in Inventory needed for the project is expected to be $775,000 with an expected increase in Accounts Payable of $255,000.

o The equipment falls into the IRS 5-year class life using the MACRS depreciation method with the year convention. The IRS depreciation table is:

Year	Depreciation (% of depreciable basis)
1	20.00%
2	32.00%
3	19.20%
4	11.52%
5	11.52%
6	5.76%

The program (project) is planned to continue for 9 years. At the end of the project the equipment will be salvaged (sold). The forecasts predict that the equipment can be sold then for $165,000.

The Net Operating Working Capital (Inventory and Accounts Payable) is expected to be liquidated at the end of the project (Year 9).

The project is expected to operate as a new division and the projection for new sales revenues is:

o Estimated sales in year 1: $2,125,000

o Sales are expected to grow by

50% in year 2,

25% in year 3,

15% per year in years 4 and 5,

10% in year 6, and then

5% per year thereafter.

Production cost forecasts are:

o Fixed costs: $234,000 per year.

o Annual variable costs: 42% of revenue

SPI has a marginal (federal + state) tax rate (T) of 34%.

The firms beta is 1.48,

The risk free rate of return (rrf) = 2.25%,

The market risk premium (rm rrf) = 4.25%,

The firms analysts have partially prepared information for SPIs cost of capital at various levels of debt and equity:

D/E	D/A (Wd)	rd	rd(1-T)	b	E/A (Wce)	re	WACC
0	0.000	0.00%	0.00%	1.24	1.000	7.5%	7.500%
0.3	0.231	4.77%	3.15%	1.48	0.769	8.54%
	0.333	5.25%		1.64	0.667		7.310%
0.75		6.75%	4.46%		0.571	10.10%	7.680%

Where:

o rd = before tax cost of debt,

o rd(1-T) = after tax cost of debt,

o b = beta, o re = cost of common equity,

o Wd = Weight of debt,

o Wce = Weight of common equity,

SPI has the following levels of debt and common equity (market values):

o Debt: $250,000,000

o Equity: $833,333,333

o Total Capital: $1,083,333,333

SPIs management utilizes risk adjusted hurdle rates for evaluating capital budgeting projects. All potential projects are classified using a five level classification system:

Risk Level	Class	Hurdle Rate
A	low risk	WACC - 2
B	below average risk	WACC - 1
C	normal risk	equal to the WACC
D	above average risk	WACC + 1
E	high risk	WACC + 2

The CTEX project is considered to be High risk

Given all of the information provided in this case:

(Show your work, calculations, and explain your answers well)

Cost of Capital, Capital Structure, Hurdle Rate:

What is the firms current Weighted Average Cost of Capital (WACC) at its current capital structure.

Capital Structure theory addresses finding a firms optimal capital structure. How do you determine the optimal capital structure?

What is the SPIs optimal capital structure? (Complete the Cost of Capital & Capital Structure worksheet)

Define Hurdle rate. Based on SPIs current capital structure, what is the appropriate Hurdle Rate for the Cuba project?

Capital Budgeting:

Please complete the capital budgeting analysis for this project. You should develop the incremental cash flows:

o Initial investment cash flow at t=0,

o Operating cash flows through the life of the project,

o Terminal cash flows

You should evaluate the project using:

o Net Present Value,

o Internal Rate of Return,

o Modified Internal Rate of Return

Present your decision whether the project should be accepted or rejected, and justify.