Question

After extensive research and development, Goodweek Tires, Inc., has recently developed a new tire, the SuperTread, and must decide whether to make the necessary investment to produce and market it. The tire would be ideal for drivers doing a lot of wet weather and off road driving in addition to normal usage. The research and development costs have totaled about $9 million. The SuperTread would be put on the market for a total of four years. Test marketing costing $6 million has shown there is a significant market for the tire Goodweek must initially invest $104 million in production equipment to make the SuperTread This equipment can be sold for $45 million at the end of four years. Goodweek intends to sell the SuperTread to two distinct markets: 1) The Original Equipment Manufacturer (OEM) Market. The OEM market consists primarily of the large automotive companies that buy tires for new cars. In the OEM market, SuperTread is expected to sell for $88 per tire. The variable cost to produce each tire is $66 2) The Replacement Market. The replacement market consists of all tires purchased after the automobile has left the factory. This market allows for higher margins and Goodweek expects to sell the SuperTread for $85 per tire in this market. Variable costs are the same as the OEM market Goodweek intends to raise prices at 1.5 percent above the inflation rate and variable costs are also expected to rise at this same rate. In addition, the SuperTread will incur marketing and administrative costs of $32 million in the first year. This cost is expected to increase at the rate of inflation in subsequent years. Automotive industry analysts expect automobile manufacturers to produce 2.5 million new cars this year and project that production will grow at 3.0% per year thereafter. Each new car would need four SuperTread tires (spares are undersized, temporary tires and are not sold by Goodweek). Goodweek|expects the SuperTread to capture 17 percent of the OEM market Industry analysts estimate that the replacement tire market will be 18 million tires this year and that it will grow at 1 percent annually. Goodweek expects the SuperTread will capture a 12 percent market share The appropriate depreciation schedule for the production equipment is the 5-year MACRS schedule (20%-32%-19.2%-11.52 %-11.52%-5.76%). The immediate initial working capital requirement is $18 million. Beginning in the first year of the project, the investment in net working capital will be 16 percent of sales. The investment in net working capital will be recaptured in the last year of the project Goodweek's corporate tax rate is 40 percent. Annual inflation is expected to remain constant at 2.0 percent. The cost of capital for the project is 10.3 percent COMPLETE THE CASH FLOW TABLE BELOW AND CALCULATE THE NPV AND IRR FOR THE PROJECT.

Answer 1

Year	0	1	2	3	4	Remarks
Sales
OEM Market
(No of tires)		1,700,000	1,751,000	1,803,530	1,857,636	(Ref W.N.1)
Sale price per tire		91.11	94.32	97.65	101.10	(inflation 2% p.a, increase in price @ 1.5%)
Total Sale value OEM market    (A)	-	154,880,880	165,158,620	176,118,381	187,805,421
Replacement Market
(No of tires)		2,160,000	2,181,600	2,203,416	2,225,450
Sale price per tire		88.00	91.11	94.32	97.65	(inflation 2% p.a, increase in price @ 1.5%)
Total Sale value Replacement market (B)	-	190,081,080	198,758,852	207,832,789	217,320,980
Total Sales (A+B)                                   ( C )	-	344,961,960	363,917,472	383,951,171	405,126,401
Variable Cost		68.33	70.74	73.24	75.82	(inflation 2% p.a, increase in price @ 1.5%)
OEM Market		116,160,660	123,868,965	132,088,786	140,854,066
Replacement market		147,592,368	154,330,402	161,376,048	168,743,349
Total variable Cost		263,753,028	278,199,368	293,464,834	309,597,415
Marketinf & Admin Costs		32,000,000	32,640,000	33,292,800	33,958,656	inflation 2% p.a
Depreciation		14,750,000	14,750,000	14,750,000	14,750,000	Ref W.Note 3
Total Cost                                                  (D)		310,503,028	325,589,368	341,507,634	358,306,071
EBT                                                           (C-D)	-	34,458,932	38,328,104	42,443,536	46,820,330
Less:Tax @ 40%		13,783,573	15,331,242	16,977,415	18,728,132
Operation profit		20,675,359	22,996,863	25,466,122	28,092,198
Add:Depreciation		14,750,000	14,750,000	14,750,000	14,750,000
Cash Inflow	-	35,425,359	37,746,863	40,216,122	42,842,198
Cash Outflow
Equipement	104,000,000	-	-	-	(59,000,000)
Working Capital in 1st year	-	55,193,914
Initial Working Capital	18,000,000	-	-	-	(18,000,000)
Total Cash Outflow	122,000,000	55,193,914	-	-	(77,000,000)
Net Cash Flow	(122,000,000)	(19,768,554)	37,746,863	40,216,122	119,842,198
Cost of Capital @ 10.3%	1.000	0.907	0.822	0.745	0.677
Discounted net Cash Flow	(122,000,000)	(17,930,079)	31,027,921	29,961,011	81,133,168
NPV	2,192,021
IRR	13.30%

Working Notes (W.N)
1	No of tires sold in OEM market	Year 1	2	3	4
	Car production	2,500,000	2,575,000.00	2,652,250.00	2,731,817.50
	No of tires demand in market	10,000,000	10,300,000	10,609,000	10,927,270
	Goodweeks share in market @17% of OEM market demand	1,700,000	1,751,000	1,803,530	1,857,636
2	No of tires sold in replacement market	Year 1	2	3	4
	total market demand	18,000,000	18,180,000.00	18,361,800.00	18,545,418.00
	Goodweeks share @12%	2,160,000	2,181,600	2,203,416	2,225,450
3	Equipement Value	104,000,000
	Less:Sale Value	45,000,000
	Balance	59,000,000
	Depreciation SLM method for 4 years	14,750,000