The LazyMan Company is evaluating the market potential of a newly designed reclining armchair aimed at the boomer bubble. The results of an initial questionnaire that LazyMan has conducted in major markets six months ago and cost $62,000 were positive. A more comprehensive market test study that will cost an additional $225,000 was just completed and affirmed at least a 15% of the total reclining chair market. LazyMan has not yet paid for this study.

Now LazyMan is at the point where it is considering whether to invest in the assets needed to produce the reclining chairs. The chairs would be produced in a building owned by the firm. The building, which was bought by LazyMan 25 years ago for $175,000, is currently vacant but it can be sold for $825,237. The value of the building on LazyMans books is $63,000. LazyMan can depreciate this $63,000 over three years on a straight-line basis. In order to estimate the market value of the building at projects end, the company assumes that the price change will follow the trend experienced in the last 25 years. The land on which the building sits was bought for $75,000 twenty five years ago and it is valued at $262,000 today. The expected appreciation in the land value is 5.20% per year over the coming ten-year period. LazyMan assumes that it will be able to sell both the building and the land together at their expected values at the end of the projects life.

The price of the new equipment needed is $39,200,000. It will require and additional $800,000 in shipping and installation costs. The useful life of the equipment is 16 years but the company intends to use it for only the ten years that is the life of the project and then sell it at the termination of the project. It estimates its salvage value at $22,000,000. Production is estimated to be 33,360 units in the first year, rising by 16% per year for the following six years then falling by 6.5% per year for the remaining life of the project. The selling price of the chairs in the first year will be $1,280. The reclining chair market is highly competitive and LazyMan believes that the price will increase by 2.8% per year. However, the wood, leather, plastic, and other ingredients used to produce the chairs are rapidly becoming more expensive. Variable production costs that will be $700 per unit in the first year will rise by 12.6% per year for the following five years then by 6% per year for the following four years. Total fixed costs excluding depreciation expense is assumed to stay constant at $1,860,000 per year for the life of the project. In addition, LazyMan is aware of the fact that some of the demand for its new chairs will be the result of shifting demand from its sales of the existing models. It estimates that the new production will replace 5,200 units per year that bring in an after-tax EBIT of $620 per unit. The marginal tax rate applicable to this project is 28%.

LazyMan anticipates that it will maintain an investment in working capital equal to $250,000 initially (at time point zero) and rising by 5.24% per year in the first six years then declining by 14% in each of years seven, eight, and nine before is completely recovered in year ten.

LazyMan uses the straight-line depreciation for all its depreciable assets.

I) On an Excel spreadsheet, estimate the following:

1. Initial net investment (NINV) (show it clearly in one box)

2. Total after-tax salvage value (ATSV) for all relevant assets (clearly show details for each salvageable asset in another box)

3. The annual depreciation schedule

4. The annual incremental investment in NWC

5. Annual free cash flows (FCF)

At this point in the project, assume that the required rate of return on LazyMans project of similar risk is 12%.

II) Use the capital budgeting decision criteria to decide which ones point to acceptance of the new project. Show in as much detail as possible on an Excel spreadsheet how you will evaluate the project including all estimates of cash flows and all the necessary calculations. Assume LazyMan uses a required payback of 6 years or less.

III) LazyMan is not always comfortable with the estimate of its cost of capital so it uses a sensitivity analysis to check how robust its project valuations to various estimates of cost of capital. The estimate should start with 0% and increase by increments of 5% points until it reaches 30%. For each estimate an NPV is calculated to analyze the sensitivity of NPV to various discount rate assumptions. Plot the NPV profile (NPV on y-axis and discount rates on x-axis). Watch where the NPV curve intersects with the x-axis. What do you call the intersection point?

Spreadsheet is due as an Excel file (email it and keep the file) by Thursday March 19h, 2020.

(Note: your spreadsheet should be formatted in landscape and the solution to this part should not be more than one page sideways and two pages down. Use Excels round function to round the number of units to zero decimals, price per unit and variable cost per unit to two decimals. Format cells so that all numbers larger than 999 will have separators. Points will be lost for not following these instructions).