VIVIDIA

An Irvine California based high-tech firm, Arclight, is considering entering into a new line of high-definition televisions called Vividia. These televisions emerged from many years of R&D to produce proprietary state-of-the-art film-like displays that are ultrathin, ultralight, and have state-of-the-art 8K resolution. What makes the technology unique is the incredible light weight of the displays that can be hung on a wall easily without the need of heavy-duty brackets. The name Vividia was developed by the marketing department as a reference to an exceptionally vivid viewing experience. It is hoped that this is an accurate promotional reference for this new display technology.

Launching this line of televisions will require a substantial investment in plant and equipment. Arclight will need to build or purchase a manufacturing facility and purchase new equipment. The manufacturing facility, to be located in Irvine California, south of Los Angeles, is estimated to cost $55,000,000 and the new equipment $40,000,000. A new warehouse will need to be acquired which will cost $20,000,000. The addition to net working capital will be $8,000,000. Assets will be depreciated straight-line over 5 years.

Arclight will offer the TV in three display sizes: 55-inch, 65-inch, and 75-inch. For the home theater enthusiasts, Arclight will also offer a huge 100-inch model. Each TV will be equipped with the fastest computer processors available at the time the unit is sold. To keep the units lightweight, each unit will be sold with an optional sound bar that is separate from the TV. The Vividia TVs are compatible with all major sound bars on the market. As the company spokesperson says, Our vivid pictures must be matched by equally vivid sound. Of course, the real selling point is the lightweight Vividia display that Arclight claims will disrupt the TV industry.

Each TV will be sold via popular retail outlets that sell consumer electronics, such as BestBuy. It is anticipated that Arclight will sell the following number of units during the first year at the following prices: TABLE 1

Display Size	Expected Number of Units Sold in First Year	Expected Retail Price in First Year*
55-inch	10,000	$2,200
65-inch	15,000	$2,800
75-inch	15,000	$3,600
100-inch	5,000	$5,000

*Prices of all display sizes are expected to grow by 2% in each subsequent year due to inflation.

After the first year, unit sales for all panel sizes are expected to grow by 20% in year two, 12% in year three, 8% in year four, and 2% in year five. After the fifth year, Arclight executives believe that archrivals Samsung, LG, Sony, Sharp, and Toshiba will have successfully developed their own versions of the technology commoditizing the product and limiting profitability. Therefore, after year five, Arclight will exit the market.

The venture will have fixed costs of $35,000,000 during the first year and, due to cost control, are expected to grow at a rate of only 2% per year due to inflation. Variable costs will be 57% of total revenues. The firms combined tax rate is 30% (21% federal, 8.84% state, and 0.16% local).

The VP of operations believes that at the end of five years, the manufacturing facilities (including warehouse) can be sold for $25,000,000 and that the equipment (which will be technologically aged) will sell for about $1,000,000.

COST OF CAPITAL

Arclight has a target capital structure of 75% common equity, 5% preferred equity and 20% debt. It believes that this is the capital structure that minimizes the WACC and hence maximizes firm value. However, Arclight will be able to fund only 40% of its common equity requirements with internally generated cash flows. The remaining 35% of common equity will have to be raised externally, via an investment bank. The firms investment banker, Barclays Capital Markets (BCM), has quoted Arclight an underwriting fee of 9.1%, meaning the Arclight will keep only $0.909 of every dollar of external equity raised.

Arclight stock has above average in risk, with a beta of 1.60. The risk-free rate is 2% and BCM estimates the expected return on the market to be 12%. Arclights stock sells for $50 and the firm just paid a dividend of $4.63. Dividends are expected to grow at a rapid rate of 8% indefinitely. Arclight also has a preferred stock issue outstanding with shares priced at $81.52. The preferred shares pay a $12.00 annual dividend. BCMs fee to Arclight for issuing new preferred stock is 8%, meaning Arclight keeps $0.92 for each dollar raised.

The firm has one bond issue with 20 years remaining. The bond is priced at $1,150.46 in the market and pays a 14% coupon rate (paid semi-annually). BCM will also assist with debt issuance, but will not charge an underwriting fee for debt (BCM offered this in order to compete for Arclights business).

Question 1 (10 Points)

What are the component costs of capital (i.e., cost of debt, preferred equity, internal common equity, external common equity)? Calculate the Weighted Average Cost of Capital for Arclight.

Capital Component	Component Cost
Internal Common Equity
External Common Equity
Preferred Equity
Debt
WACC

Question 2 (10 Points)

Your task: Using the expected values above, determine whether the firm should pursue the Vividia TV project in Irvine? That is, what is the Net Present Value (NPV) of the investment into the Vividia TV? What is the Internal Rate of Return (IRR)?

NPV
IRR