Question

After extensive research and development, Goodweek Tires Inc. has recently developed a new tire, the Super Tread, and must decide whether to make the investment necessary to produce and market it. The tire would be ideal for drivers doing a large amount of wet weather and off-road driving in addition to normal highway usage. The research and development costs so far have totalled about $10 million. The SuperTread would be put on the market beginning this year, and Goodweek expects it to stay on the market for a total of four years. Test marketing costing $5 million has shown that there is a significant market for a SuperTread-type tire As a financial analyst at Goodweek Tires, you have been asked by your CFO, Alana Smith, to evaluate the Super Tread project and recommend whether to go ahead with the investment. Except for the initial investment, which will occur immediately, assume all cash flows will occur at vear-end Goodweek must initially invest $160 million in production equipment to make the Su- perTread. This equipment can be sold for $65 million at the end of four years. Goodweek intends to sell the Super Iread to two distinct markets 1. The original equipment manufacturer (OEM) market. The OEM market consists pri- marily of the large automobile companies (like General Motors) that buy tires for new cars. In the OEM market, the SuperTread is expected to sell for $41 per tire. The variable cost to produce each tire is $29 2. The replacement market. The replacement market consists of all tires purchased after the automobile has left the factory. This market allows higher margins; Goodweek expects to sell the Super Tread for $62 per tire there. Variable costs are the same as in the OEM market Goodweek Tires intends to raise prices at 1 percent above the inflation rate; variable costs will also increase at 1 percent above the inflation rate. In addition, the SuperTread project will incur $43 million in marketing and general administration costs the first year. This cost is expected to increase at the inflation rate in the subsequent years Goodweek's corporate tax rate is 40 percent. Annual inflation is expected to remain constant at 3.25 percent. The company uses a 13.4 percent discount rate to evaluate new product decisions. Automotive industry analysts expect automobile manufacturers to pro- duce 6.2 million new cars this year and production to grow at 2.5 percent per year thereafter. Each new car needs four tires (the spare tires are undersized and are in a different categor Goodweek Tires expects the SuperTread to capture 11 percent of the OEM market. Industry analysts estimate that the replacement tire market size will be 32 million tires this year and that it will grow at 2 percent annually. Goodweek expects the SuperTread to capture an 8 percent market share.