Valuation Case Gro-Green Industries As an analyst with Gro-Green you have been assigned to study a potential new product for the firm; an all organic super charged fertilizer mix made from residual bio-solid waste materials that Gro-Greens' R&D people developed for use on residential lawns. You have been given this assignment and are to report back your findings to the management team made up of financial and non financial managers. To this end your report should be written to such an audience in an understandable manner that demonstrates clearly your findings and recommendations. To get started you begin by gathering data for your analysis: Gro-Green's marketing manager has reported to you that he feels under this project the company can sell 25,000 bags in the first year and that volume will increase by 15% in each year thereafter for the next 3 years after which time the product will become obsolete when replaced by newer cheaper products. The selling price for each 25 lb bag will be 22.95. You determine through data provided by accounting that current assets under this project (receivables and inventories) would increase by $42,000 as the firm would need to extend additional credit to retailers and increase inventory levels. Also current liabilities (accounts payable and accruals) would rise by $34,000 as a direct result of taking on this program. The required equipment cost is $193,000, plus another $15,000 for shipping and installation. The production facility will be located in a currently vacant building the firm owns. Variable costs of production are estimated to be 72 percent of sales revenues. In your discussion with production management you found it interesting to learn that the actual input of raw materials and labor are estimated only make up a small amount of the total variable cost; about 25% of it, and remaining portion is related to cost of power (Electricity and Gas) required to process the bio solids into a finished bagged item ready for sale. Fixed costs (exclusive of depreciation) will be $85,000 per year. And the fixed assets of equipment and installation will be depreciated under MACRS with a 5-year life. (Refer to Appendix 12A table 12a-2 page 435 for MACRS depreciation rates.) When production ceases after 4 years, it is estimated the equipment will have a remaining market value of $15,000. As a firm Gro-Green has a current tax rate is 42 percent. At the time of taking on this project the firm has outstanding long term debt of 4,500,000 at an average borrowing rate of 6.2%. The firm has no outstanding preferred shares. And has equity of 8,100,000 with a required rate of return to investors of 12%. The firm is currently financed within its optimal capital budget structure. Now onto the Analysis: The aspects that should be specifically considered and discussed in your report back to management are as follows: a. What is the weighted average cost of capital to the firm which you will be using to discount cash flows at for your project? b. Find the required Year 0 investment, the annual after-tax operating cash flows, and the terminal year cash flow, and then calculate the project's NPV, IRR, MIRR, and payback. Assume at this point that the project is of average risk. c. Management expresses concern that some of the base-case inputs might be too optimistic or too pessimistic, and he wants to know how the NPV would be affected if these variables were all 20% better or 20% worse than the base-case level. In question are 6 variables: unit sales, sales price, variable costs, fixed costs, WACC, and equipment cost. Hold other things constant when you consider each variable, and construct a sensitivity graph to illustrate your results. Please see the capital budget model posted with this assignment as a helpful guide to parts B & C. d. From the analysis above discuss findings on part a & b and especially the results of NPV, IRR, MIRR and payback for this project. Make sure your discussions assist non financial managers in understanding how to interpret the results. e. As well discuss the sensitivity of the given variables in part C and how they may impact any decisions on this project. Particularly what potential risks and opportunities do we discover through such analysis? e. Also you learn there are additional facts about this project that need to be considered and discussed as for how they may potentially impact the NPV to this project. You learn from accounting that R&D costs to develop the organic fertilizer formulation and production process for the new product were $30,000, and those costs were incurred and expensed for tax purposes last year. As well it