Sheet1
Chapter 6
Goodweek Tires, Inc.
NAME:
Input area:
Research and development $ 10,000,000 Sunk Cost - excluded from Cash Flow
Test marketing cost $ 5,000,000 Sunk Cost - excluded from Cash Flow
Initial equipment cost $ 160,000,000
Equipment salvage value $ 65,000,000 Comoute Each Year Depreciation
Year 1 depreciation 14.30% $ 22,880,000.00
Year 2 depreciation 24.50% $ 39,200,000.00
Year 3 depreciation 17.50% $ 28,000,000.00
Year 4 depreciation 12.50% $ 20,000,000.00
OEM market:
Price $ 41
Variable cost $ 29
Automobile production 6,200,000
Growth rate 2.50%
Market share 11.00%
Replacement market:
Price $ 62
Variable cost $ 29
Market size 32,000,000
Growth rate 2.00%
Market share 8.00%
Price increase above inflation 1%
VC increase above inflation 1%
Marketing and general costs $ 43,000,000
Tax rate 40.00%
Inflation rate 3.25%
Required return 13.40%
Initial NWC $ 9,000,000
NWC percentage of sales 15%
Output area:
Nominal price increase 4.28% Computed for you
Nominal VC increase 4.28% Computed for you
Year 0 Year 1 Year 2 Year 3 Year 4
OEM:
Automobiles sold 6,200,000 6,355,000 6,513,875 6,676,722 Computed for you
Tires for automobiles sold 24,800,000 25,420,000 26,055,500 26,706,887 Computed for you
SuperTread tires sold 2,728,000 2,796,200 2,866,105 2,937,758 Computed for you
Price per Tire $ XXXXXXXXXX $ XXXXXXXXXX $ XXXXXXXXXX $ XXXXXXXXXX Computed for you
Replacement market:
Total tires sold in market
SuperTread tires sold
Price per Tire
Revenue:
OEM market
Replacement market
Total
Variable costs:
VC per Tire
Total VC in OEM market
Tot VC in Replacement market
Total
Revenue
Variable costs
Marketing and general costs (43,000,000) (44,397,500) (45,840,419) (47,330,232) Computed for you
Depreciation
EBT
Tax
Net income
OCF
New working capital: Values inputed for you Values inputed for you
Beginning 0 $ 9,000,000
Ending 9,000,000 - -
NWC cash flow $ (9,000,000) $ 9,000,000 $ - $ - $ - Computed for you
Book value of equipment $ 160,000,000
Aftertax salvage value:
Market value
Taxes
Total
Year 0 Year 1 Year 2 Year 3 Year 4
Operating cash flow
Capital spending
NWC Cash flow
Total cash flows
NPV
IRR
Profitability index
Sheet2
Sheet3
GOODWEEK TIRES, INC.
After extensive research and development, Goodweek Tires, Inc., has recently developed a new tire,
the SuperTread, 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 freeway usage. The research and development costs so far have totaled 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, Adam Smith, to eval-
uate the SuperTread project and provide a recommendation on whether to go ahead with the invest-
ment. Except for the initial investment that will occur immediately, assume all cash flows will occur at
year-end.
Goodweek must initially invest $120 million in production equipment to make the SuperTread.
This equipment can be sold for $51 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 primal--
Fly of the large automobile companies (e.g., General Motors) who buy tires for new cars. In the
OEM market, the SuperTread is expected to sell for $36 per tire. The variable cost to produce
each tire is $18.
2. The Replacement Market The replacement market consists of all tires purchased
after the automobile has left the factory. This market allows higher margins and Goodweek
expects to sell the SuperTread for $59 per tire there. Variable costs are the same as in the
OEM market.
iloodweek fires intends to ruse prices at I percent above Me inflation rate; variable costs will also
Increase 1 percent above the inflation rate. In addition, the Super [read project will incur $25 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 15.9 percent discount rate to evaluate new product decisions.
Automotive industry analysts expect automobile manufacturers to produce 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 category). Goodweek Tires expects the SuperTread
to capture 11 percent of the OEM market.
Industry analysts estimate that the replacement tire market size will be 14 million tires this yea
and that it will grow at 2 percent annually. Goodweek expects the SuperTread to capture an 8 percent
market share.
The appropriate depreciation schedule for the equipment is the seven-year MACRS depreciation
schedule. The immediate initial working capital requirement is $11 million. Thereafter, the net working
capital requirements will be 15 percent of sales. What are the NPV, payback period, discounted pay-
ack period, AAR. IRE, and PI on this project?
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