Your team is composed of THREE or TWO financial analysts assigned to the Gadget Division of The FGM Corporation, the largest multinational automobile manufacturer in the world. Your team is asked to evaluate a project proposal regarding the production of a device, DEVICE, which applies the most advanced artificial intelligence technology to improve driving safety. This upgradeable built-in device gives warnings to drivers and assist them to stay in lane and avoid collision. The DEVICE will be marketed as an optional feature for FGM cars and trucks. A comprehensive market analysis on the potential demand for this device was conducted and completed last year at a cost of $15M, where M is for millions. From the comprehensive market analysis, your team expects annual sale volume of DEVICE to be 5M units for the first year and will decrease by 500,000 units annually in the following two years. The unit price of the device is $995 (expressed in constant t=0 dollar, i.e., in real term). Due to the introduction of similar products by competitors at the end of Year 3, the expected annual sale volume will drop to 3M units and the unit price is expected to fall to $745 (expressed in constant t=0 dollar, i.e., in real term) in the year following the introduction of the competitive products. Unit production costs are estimated at $900 (expressed in constant t=0 dollar, i.e., in real term) at the beginning of the project, and will not be impacted by the change in competition. Annual nominal growth rates for unit prices and unit production costs are expected to be 3.0% and 4.0%, respectively, over the life of the project. In addition, the implementation of the project demands current assets to be set at 20% of the annual sale revenues, and current liabilities to be set at 14% of the annual production costs. Besides, the introduction of DEVICE will increase the sales volume of cars and trucks that leads to an increase in the annual after-tax operating cash flow of FGM by $14M (expressed in constant t=0 dollar, i.e., in real term) for the first three years, and $10M (expressed in constant t=0 dollar, i.e., in real term) afterwards. The production line for DEVICE will be set up in a vacant plant site (land) purchased by FGM at a cost of $50M thirty years ago. This vacant plant site has a current market value of $40M, and is expected to be sold at the termination of this project for $55M in five years. The machinery for producing DEVICE has an invoice price of $120M, and its customization costs another $10M for meeting the specifications for the project. The machinery has an economic life of five years, and is classified in the MACR 5-year asset class for depreciation purpose. The sale price of the machinery at the termination of the project is expected to be 10% of its initial invoice price. The corporate handbook of The FGM Corporation states that corporate overhead costs should be reflected in project analyses at the rate of 5% of the book value of assets. Corporate overhead costs are not expected to change with the acceptance of this project. However, financial analysts at the Headquarters believe that every project should bear its fair share of the corporate overhead burden. On the other hand, the Director of the Gadget Division disagrees to this view and believes that the corporate overhead costs should be left out of the analysis. The (nominal) discount rate for the project is assumed to be 14%, compounded daily. The marginal tax rate of The FGM Corporation is 21%. And any tax loss from this project can be used to write off taxable income of The FGM Corporation. The general inflation rate is 3.5%.

Question 4:Being diligent professionals, your team is not satisfied with the assumed discount rate in the base scenario that is given to you. From your teams research, your team notes that The FGM Corporation issued three types of securities to finance its businesses. It has 2B shares of its common stock outstanding, which is priced at $60 per share. The stock beta is estimated at 1.40. In addition, the Corporations 10% coupon, $40B par, 15-year, B-rated semiannual coupon paying bonds are priced at a premium of 8% relative to its par. In addition, The FGM Corporation also finances its operation with 100M shares of its preferred stock, which pays annual DPS of $6 and is currently priced at $75 per share. Currently, the yields on long-term Treasury securities are around 4.0%. Your team references the stock market statistics reported in the Ibbotsons SBBI Yearbook (or Chapter 10 in the text) for the estimation of the market risk premium. Your team believes that the riskiness of the Project is compatible with that of other projects of the company. Base on your teams analysis, you redo the above analyses and address the above issues, i.e., Q1 ~ Q4 by showing your work to your supervisor. Are there any differences in your recommendations? Why or why not?