X Analytics manufactures a variety of electronic products. The company is considering introducing its most exciting product; a new digital instrument panel for customized classic cars. This panel allows the car owner to customize the complete set of instruments for the vehicle. Output display may be analog or digital, with many styles of display using apps that may be purchased, downloaded, and installed with a micro SD card. Market studies indicate that the Fully Customizable Instrument Panel (FCIP) may be valuable to any vehicle owner that wants to customize their car and add another layer of diagnostic information at their fingertips, and especially to an enthusiast. The company analyst interns have also provided the following forecasts for the project. -The company will have to purchase a new machine to produce the new product. The equipment, including shipping and installation is expected to cost (t=0) $ 5,276,000. -If the company goes ahead with the proposed product, it will have an effect on the companys net operating working capital. At the outset, t = 0, inventory will increase by $235,000. Accounts payable will increase by $51,000 and accounts receivable will increase by $41,000. -The net operating working capital will be liquidated after the project is completed. -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 $95,000. -The equipment falls into the IRS 5-year class life using the MACRS depreciation method with the year convention

YEAR	Depreciation (% of depreciable basis)
1	20%
2	32%
3	19.20%
4	11.52%
5	11.52%
6	5.76%

Sales Forecast: The estimates of sales revenues for this project are:

-Year 1: 1,250,000

-Year 2: 2,875,000

-Year 3: 3,450,000

-Sales are expected to continue to grow in years 4, 5, and 6 by 10% per year.

-Sales are then expected to decline by 15% per year in years 7, 8, and 9.

Production cost forecasts are:

-Fixed costs: $234,000 per year.

-Annual variable costs: 51% of revenue.

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

Your analysts compiled current market information:

-Market risk premium (rm rrf): 4.25%

-Risk-free rate (rrf): 1.82%

The companys beta (at its current capital structure) is: 1.37

Current Capital Structure Fanning has the following levels of debt and common equity (market values):

-Debt: $2,450,000

-Equity: $7,350,000

-Total Capital: $9,800,000

Fanning Analytics uses the firms WACC for average risk projects, it adds 2% for high risk projects. For low risk projects it uses the WACC less 2%.

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

Fanning Analytics considers this to be a high risk project.

After discussions with an investment banker about issuing additional debt, your analyst found that the cost of debt (before tax) depends on the amount of debt in the capital structure. Fanning Analytics cost of debt estimates for various levels of debt financing (D/E) were obtained and the firms analysts have partially prepared information for the companys cost of capital at various levels of debt and equity:

Capital Structure Worksheet
D/E	D/A (Wd)	rd	rd(1-T)	b	E/A (Wce)	rs	WACC
0	0.000	0.00%	0.00%	1.12	1.000	6.59%	6.593%
0.33	0.250	5.12%	3.38%	1.37	0.750	7.64%	6.577%
	0.333	5.25%		1.49	0.667		6.600%
0.75		6.75%	4.46%		0.571	8.95%	7.026%

Cost of Capital, Capital Structure, Hurdle Rate:

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

-What is the SPIs optimal capital structure?

-Define Hurdle rate.

-What is a Risk-adjusted Hurdle Rate?

-Based on SPIs current capital structure, what is the appropriate Hurdle Rate for the project?

Capital Budgeting:

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

-Initial investment cash flow at t=0,

-Operating cash flows through the life of the project,

-Terminal cash flows

You should evaluate the project using:

-Net Present Value,

-Internal Rate of Return,

-Modified Internal Rate of Return

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