- Which of the two print heads should be used in the high-efficiency printers if you decide to go ahead with the project and why?
Exhibit 1 Sales forecasts: The forecasts are based on projected levels of demand. The firm could face weak, average, and strong demand. All the numbers are expressed in today's dollars. The forecasted average inflation per year is 3.0%. Demand level Weak Average Strong 30% Probability 25% 45% Price per high-efficiency printers $90 $95 $97 Units sold per year 400,000 425,000 450,000 $18 Labor cost per high-efficiency printers Parts $7 Selling General & Administrative $10,000,000 Average warranty cost per year per high-efficiency printers for the first five years is $5. The present value of this cost will be used as a cost figure for each high-efficiency printers. Afterwards, the high-efficiency printers owners will become responsible the repairs. The high-efficiency printers can be produced for eight years. Afterwards, the designs become obsolete. Exhibit 2 Print head costs: Print head choices: Print head model number PC-004 $10 TP-L12 $6 Price per print head and installation $1 $2 Average annual warranty cost per year for five years. Afterwards, the high-efficiency printers owner will become responsible the repairs*. The chosen print head will be installed in every high-efficiency printers and will become a cost figure for each unit produced. * The print head manufacturers are not providing Business Machines with any warranty. However, Business Machines will provide warranty to its customers. After the initial five years, the high-efficiency printer's owners may purchase extended warranty from any insurance company that offers such packages. Exhibit 3 Investment needs: To implement the project, the firm has to invest funds as shown in the following table: Year 1 Year 0 $14 million Production and selling of commercial appliances starts MACRS depreciation will be used. To facilitate the operation of manufacturing the high-efficiency printers, the company will have to allocate funds to net working capital (NWC) equivalent to 10% of annual sales. The investment in NWC will be recovered at the end of the project. Exhibit 4 Financing The following assumptions are used to determine the cost of capital. Historically, the company tried to maintain a debt to equity ratio equal to 0.50. This ratio was used because lowering the debt implies giving up the debt tax shield and increasing it makes debt service a burden on the firm's cash flow. In addition, increasing the debt level may cause a reduced rating of the company's bonds. The marginal tax rate is 35%. All the numbers are expressed in today's dollars. The forecasted average inflation per year is 3.0%. Cost of debt: The company's bond rating is roughly at the high end of the A range. Surveying the debt market yielded the following information about the cost of debt for different rating levels: Bond rating AA A BBB Interest cost range 4.5% ~ 6.0% 5.75% ~ 7.5% 7.5% ~ 9% The company's current bonds have a rating of AA. Cost of equity: The current 10-year Treasury notes have a yield to maturity of 3% and the forecast for the S&P 500 market premium is 6.5%. The company's overall is 1.0. analysis: The company was able to develop a list of printer manufacturers, but had a list of appliances manufacturers. Company Business Electrics General Universal Stevenson, International Machines Plus Offsets Publishing Inc. Paper Offset Equipment Over all B 1.0 1.4 1.3 1.6 1.2 1.35 Debt to 0.5 0.3 0.5 0.45 0.35 0.25 equity Percentage 50 45 90 95 85 85 of income from Appliances Exhibit 1 Sales forecasts: The forecasts are based on projected levels of demand. The firm could face weak, average, and strong demand. All the numbers are expressed in today's dollars. The forecasted average inflation per year is 3.0%. Demand level Weak Average Strong 30% Probability 25% 45% Price per high-efficiency printers $90 $95 $97 Units sold per year 400,000 425,000 450,000 $18 Labor cost per high-efficiency printers Parts $7 Selling General & Administrative $10,000,000 Average warranty cost per year per high-efficiency printers for the first five years is $5. The present value of this cost will be used as a cost figure for each high-efficiency printers. Afterwards, the high-efficiency printers owners will become responsible the repairs. The high-efficiency printers can be produced for eight years. Afterwards, the designs become obsolete. Exhibit 2 Print head costs: Print head choices: Print head model number PC-004 $10 TP-L12 $6 Price per print head and installation $1 $2 Average annual warranty cost per year for five years. Afterwards, the high-efficiency printers owner will become responsible the repairs*. The chosen print head will be installed in every high-efficiency printers and will become a cost figure for each unit produced. * The print head manufacturers are not providing Business Machines with any warranty. However, Business Machines will provide warranty to its customers. After the initial five years, the high-efficiency printer's owners may purchase extended warranty from any insurance company that offers such packages. Exhibit 3 Investment needs: To implement the project, the firm has to invest funds as shown in the following table: Year 1 Year 0 $14 million Production and selling of commercial appliances starts MACRS depreciation will be used. To facilitate the operation of manufacturing the high-efficiency printers, the company will have to allocate funds to net working capital (NWC) equivalent to 10% of annual sales. The investment in NWC will be recovered at the end of the project. Exhibit 4 Financing The following assumptions are used to determine the cost of capital. Historically, the company tried to maintain a debt to equity ratio equal to 0.50. This ratio was used because lowering the debt implies giving up the debt tax shield and increasing it makes debt service a burden on the firm's cash flow. In addition, increasing the debt level may cause a reduced rating of the company's bonds. The marginal tax rate is 35%. All the numbers are expressed in today's dollars. The forecasted average inflation per year is 3.0%. Cost of debt: The company's bond rating is roughly at the high end of the A range. Surveying the debt market yielded the following information about the cost of debt for different rating levels: Bond rating AA A BBB Interest cost range 4.5% ~ 6.0% 5.75% ~ 7.5% 7.5% ~ 9% The company's current bonds have a rating of AA. Cost of equity: The current 10-year Treasury notes have a yield to maturity of 3% and the forecast for the S&P 500 market premium is 6.5%. The company's overall is 1.0. analysis: The company was able to develop a list of printer manufacturers, but had a list of appliances manufacturers. Company Business Electrics General Universal Stevenson, International Machines Plus Offsets Publishing Inc. Paper Offset Equipment Over all B 1.0 1.4 1.3 1.6 1.2 1.35 Debt to 0.5 0.3 0.5 0.45 0.35 0.25 equity Percentage 50 45 90 95 85 85 of income from Appliances
