Question

The following information will tell us if the CUBE project can increase the market value of Cool Stuff, Inc. Equipment to produce CUBE will cost $750 million and an area of the current plant will have to be renovated at a cost of $50 million to accommodate it. The area to be renovated is valued at $10 million but a competing team has identified a Chinese firm willing to pay $1 million per year to lease the space. The engineering department estimates it has spent $10 million developing the device. Market testing cost an additional $2 million. Revenues are expected to be $250 million in the first year and are projected to grow by 25% in year two, 50% in year three and 100% in year four, after which it is expected to fetch $500 million in the market. Variable costs are expected to be 25% of sales per year for the life of the project. Fixed costs are estimated at $5 million per year. The capital expenditures will be depreciated using a three-year MACRS schedule. CUBE will require an additional $25 million investment in inventory at start up, then $50 million in the first year. A unique arrangement with current distributors will increase accounts receivables by $5 million. Consultants also estimate the beta of the project will be 2.0, the treasury rate is 2%, the MRP is 6%. Cool Stuff pays a 40 percent marginal tax rate and has equity of $2 billion, debt of $500 million and 100 million shares outstanding. Their marginal tax rate is 40% and they are paying a 6% coupon on their debt, which is currently trading at face value.

a. Calculate the expected annual net cash flows for CUBE

b. Calculate the WACC for the project.

b. What is the value of the proposed project? (What is the CUBE project worth?)

c. How much value is added or lost to Cool Stuff, Inc. if the project is undertaken?

d. How much will the project add or reduce Cool Stuff’s stock price. e. Describe three reasonable factors management could change about the project to enhance its value.