Question

For this Master It! assignment, refer to the Goodweek Tires, Inc., case at the end of this chapter. For your convenience, we have entered the relevant values such as the price and variable costs in the case on the next page. For this project, answer the following questions:

a. What is the profitability index of the project?

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b. What is the IRR of the project?

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c. At what OEM price would Goodweek Tires be indifferent to accepting the project? Assume the replacement market price is constant.

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d. At what level of variable costs per unit would Goodweek Tires be indifferent to accepting the project?

Answer 1

Profitability index

It is an index that computes dollars that will be returned for every dollar that is invested in the project. It is computed by diving the present worth of future cash inflows and the present worth of cash outflows.

Internal Rate of Return (IRR)

It is that rate of return that a company expects to earn from an investment that it is about to make. It is the return that will be generated from the cash inflows that the project will generate over its life.

(a)

In the present case, the cost of the project is $160 million and the project requires $9 million as a working capital investment. The tires sold in two markets. The selling price of the tire is OEM market is $41 per tires and the company capture 11% of OEM market.

The expected car sold in OEM market is 6.2 million and each car requires 4 tires. The market will grow at 2.5%. Compute the PI of the project using the equation as follows:

Hence, the PI of the project is

b.

Compute the IRR of the project using MS-excel as follows:

The result of the above excel table is as follows:

Hence, the IRR of the project is

Working notes

1.

Compute the nominal growth rate using the equation as follows:

Hence, the nominal growth rate is 4.28%.

2.

Compute the number of cars sold in automobile market using the equation as follows:

Year 2

Hence, the car sold in year 2 is $6,355,000.

Year 3

Hence, the car sold in year 3 is $6,513,875.

Year 4

Hence, the car sold in year 4 is $6,676,722.

3.

Compute the tires sold by the company in OEM market as follows:

The result of the above excel table is as follows:

Hence, the tires sold in OEM in year 1, year 2, year 3 and year 4 is 2,728,000, 2,796,200, 2,866,105 and 2,937,758 respectively.

4.

Compute the number of tires sold in replacement market by the company as follows:

The result of the above excel table is as follows:

Hence, the tires sold in replacement market in year 1, year 2, year 3 and year 4 is 2,560,000, 2,611,200, 2,663,434 and 2,716,692 respectively.

5.

Compute the total sales value of tires in both the markets as follows:

The result of the above excel table is as follows:

Hence, the total sales of year1, year2, year3 and year4 is $270,568,000, $288,374,452, $307,330,210 and $327,569,160 respectively.

6.

Compute the total variable cost of tires as follows:

The result of the above excel table is as follows:

Hence, the variable cost of year1, year2, year3 and year 4 is 4153,352,000, $163,526,265, $174,369,672 and $185,915,398 respectively.

7.

Compute the depreciation on equipment using the equations as follows:

Using the depreciation table issued by the tax authorities of united states, the rates applicable to fixed assets having 7 years of life is 14.29%, 24.49 %, 17.49% and 12.49% for year1, year 2, year3 and year 4 respectively.

Depreciation for year 1

Hence, the depreciation for year 1 is $22,864,000.

Depreciation for year 2

Hence, the depreciation for year 2 is $39,184,000.

Depreciation for year 3

Hence, the depreciation for year 3 is $27,984,000.

Depreciation for year 4

Hence, the depreciation for year 4 is $19,984,000.

8.

Compute the after-tax salvage value of equipment as follows:

The result of the above excel table is as follows:

The after-tax salvage value of the equipment is $58,993,600.

9.

Compute the change in the networking capital as follows:

The result of the above excel table is as follows:

Hence, the change in net working capital of year1, year2, year3 and year4 is ($31,585,200), ($2,670,968), ($2,843,364), $46,099,532 respectively.

10.

Compute the annual marketing cost as follows:

The result of the above excel table is as follows:

Hence, the marketing cost of year1, year2, year3 and year4 is $43,000,000, $44,397,500, $45,840,419 and $47,330,232 respectively.

11.

Compute the annual cash flow of project as follows:

The result of the above excel table is as follows:

Hence, the annual cash flow for year0, year1, year2, year3 and year4 is ($169,000,000), $22,090,000, $61,273,044, $60,622,307 and $169,680,850 respectively.

12.

Compute the present value of cash flows using the equation as follows:

The result of the above excel table is as follows:

Hence, the present value of cash flows is $211,397,625.

c.

Compute the indifference OEM market price using the equation as follows:

Hence, the indifference OEM market price is

d.

Compute the indifference variable cost using the equation as follows:

Hence, the indifference variable cost of OEM tires is

Working note

Compute the NPV of the project using MS-excel as follows:

The result of the above excel table is as follows:

Hence, the NPV of the project is $42,397,625