You run a firm focused on convenience stores that is considering entry into the frozen food market.This is a billion dollar market (in annual sales) of which you believe you can capture market share as follows: 10% of industry sales in each of the next three years.This new venture will be overseen by a team from headquarters that costs you $3 million in annual salary and other direct costs such as benefits but which currently oversees a smaller business that generates $4 million in yearly pre-tax profit.You believe that removing this team from their current business will make that business worthless.Headquarters also has the practice of allocating an extra charge of a 10% premium on top of the direct costs in order to capture the firm overhead costs via allocation.You also will employ a piece of property that you previously bought for $5 million but could now sell for $7 million and is expected to stay at that value for the next 3 years.You will only sell it, however, if you decide against this new venture.

Other costs include costs of good sold which are always 40% of sales for all businesses your firm undertakes and there are also annual operating costs of $9 million.You also perceive some other implications of the project.First, you will increase the pre-tax profitability (and cash flow) of the existing convenience store business by $10 million through better coordinated pricing between the vertically related businesses.But you also would upset some of your current suppliers who you expect to respond with more competitive pressure that results in a 10% decrease in your convenience store sales.The investment required for this project is $100 million - with 90% coming from PPE and the remainder for net working capital.Note that the NWC will be constant over the next three years.Your figures are flat for a 3-year horizon, afterwards you expect the business to have negligible value - thus, assume that the project lasts three years and then ends with no after-tax salvage value at all other than the property and the return of the NWC. The corporate tax rate is 30% and you will straight-line depreciate over the 3 years.Assume that all cash flows are year-end except for the up-front investment.

 

You also have the following financial data pertaining to the market and to your publicly-traded competitors:

Treasury

SecurityRate

3-month T-bill4%

1-Year T-bond5%

3-year T-bond6%

30-year T-bond7%

Market Risk Premium over Treasury Bonds is 6%

Your FirmFrozFoodEZ Cook.

Stock Price$6$8$12.50

Total Book Capitalization$110 Million$120 Million$125 Million

Leverage Ratio (Book)0.00.1660.2

Shares Outstanding20 Million10 Million 8 Million

Beta (Equity)1.0 0.91.0

Total Sales$200 Million$210 Million $200 Million

Frozen Food Sales$0 Million$200 Million$160 Million

Show whether you should undertake this project by performing a DCF - assuming you properly borrow $50 million at an interest rate of 8%. [55 points]