Goodweek expects the Super Tread to stay on the market for a total of

four years.

The research and development cost 10,000,000

Test marketing costing 10,000,000
Investment 160,000,000
Tax rate 40%
Inflation 3.25%
Discount rate 13.40%
Rasie prices above the inflation rate 1%
Variable costs above inflation rate 1%
Equipment can be sold end year 73,000,000
Incur marketing 43,000,000
Production to grow at 2.50%
Automobile manufactures 6,200,000
Number tire of product first year 32,000,000
Number tire of product grow at 2%
Market share 8%
Capital requirement 9,000,000
Net working capital 15%
Capture OEM market 11%

*The calculation of cash flows:

Equipment cost: Goodweek must initially invest $160 million in production

equipment to make the Super Tread. This equipment can be sold for $73 million
at the end of four years.

1.The original equipment manufacturer

Sell 41
The variable costs 28
2. The replacement market
Sell 62
The variable costs 28
 *According to the seven-year MACRS depreciation schedule and the
initial investment, the depreciation of each year is:

1st year: depreciation= 160,000×0.143= 22,880,000

 
2nd  year: depreciation= 160,000×0.245= 39,200,000
 
3rd year: depreciation= 160,000×0.175= 28,000,000
 
4th  year: depreciation= 160,000×0.125= 20,000,000

*The calculation are:

Depreciation costs: Modified Accelerated Cost Recovery System (MACRS) method

has been used in calculating the depreciation.

Year MACRS % Depreciation Book Value

1 0.143 22,880,000 137,120,000
2 0.245 39,200,000 97,920,000
3 0.175 28,000,000 69,920,000
4 0.125 20,000,000 49,920,000
5 0.089 14,240,000 35,680,000
6 0.089 14,240,000 21,440,000
7 0.089 14,240,000 7,200,000
8 0.045 7,200,000 0

*According to the data, we can calculate the OCF through the

sales, costs and depreciation and so on.

1. The original equipment manufacturer

Total number of car in EOM market

6,200,000 units
at the first year:
So the number of tires will be : 24,800,000 units
Total demand for Super Tread in the
2,728,000.0 units
EOM market in the first year:

Year Sales Price Sales VC/ VC Dep

 s unit Revenue unit
1 2,728,00 41 111,848,00 28 76,384,00 22,880,00
0 0 0 0
2 2,796,20 42.7 119,516,57 29.2 81,621,07 39,200,00
0 4 9 8 0
3 2,866,10 44.5 127,710,93 30.4 87,217,22 28,000,00
5 6 4 3 0
4 2,937,75 46.4 136,467,11 31.7 93,197,05 20,000,00
8 5 5 4 0

2. The replacement market

Total number of car in EOM

2,560,000 units
market at the first year:

Year Sales price sales VC/ VC Dep

s unit revenue unit
1 2,560,00 62 158,720,0 28 71,680,00 22,880,00
0 00 0 0
2 2,611,20 64.6 168,774,9 29.19 76,220,92 39,200,00
0 4 12 8 0
3 2,663,42 67.3 179,466,8 30.43 81,049,52 28,000,00
4 8 03 4 0
4 2,716,69 70.2 190,836,0 31.72 86,184,01 20,000,00
2 5 25 1 0

*TOTAL REVENUE & VARIBLE COST

Year 1 2 3 4
Sales unit 5,288,000 5,407,400 5,529,529 5,654,450
Sales
270,568,000 288,291,491 307,177,737 327,303,139
revenue
Varible cost 148,064,000 157,842,006 168,266,747 179,381,065

*CAPITAL GAIN ON SALVALVAGE VALUE

Corporate tax will be applicable on capital gain. Salvage value will be
adjusted for tax on capital gain. The calculation is:

Salvage value 73,000,000

Book value 49,984,000
Capital gain 23,016,000
Tax 9,206,400.0
After tax capital gain 63,793,600

-The OCF of the Goodweek Tires is:

 
*Net Present Value (NPV):
NPV of the project refer to total Present value (PV) of future cash flow + Initial
investment.
An acceptance criterion is: Accept if NPV > 0

In this case we have used 13.4% as the discount rate. Using the
worksheet we get the OCF is:

Year 1 2 3 4
270,568,00 288,291,49 307,177,73
Sale revenue 327,303,139
0 1 7
148,064,00 157,842,00 168,266,74
Variable cost 179,381,065
0 6 7
Dep 22,880,000 39,200,000 28,000,000 20,000,000
110,910,99
Income 99,624,000 91,249,485 127,922,074
0
taxes 39,849,600 36,499,794 44,364,396 51,168,830
Income after
59,774,400 54,749,691 66,546,594 76,753,245
taxes

NPV for the new tire is :

= ((-160,000,000) + (59,774,400/(1+13.4%)) + (54,749,691/(1+13.4%)2)
+ (66,546,594/(1+13.4%)3) + (76,753,245/(1+13.4%)4))
= 27,333,525 >0
Comment: If the NPV is positive , we accept this project

*PAY BACK PERIODS (PP)

This refer to the amount of time (in years, month, etc) required to recover the initial
cost.

Year 1 2 3 4
Opening
160,000,00 100,225,60 -
balance new 45,475,909
0 0 21,070,684
product
Cash flow 59,774,400 54,749,691 66,546,594 76,753,245
100,225,60 - -
Ending balance 45,475,909
0 21,070,684 97,823,929

The PBP of this new product will be:

= 3 + ( 21,070,684/ 76,753,245)
= 2.73 years
 
*DISCOUNTED PAYBACK
This method accounts for the time value by discounting the cash flows by the
discount rate:
This refer to the amount of time (in years, month, etc) required to recover the initial
cost:

Year 1 2 3 4
Opening balance
160,000,000 100,225,600 45,475,909 (21,070,684)
new product
Cash flow 59,774,400 54,749,691 66,546,594 76,753,245
Ending balance 100,225,600 45,475,909 (21,070,684) (97,823,929)

Discounted Payback period :

= 3+ [- ((-160,000,000)+59,774,400+54,749,691+66,546,594)) /
76,753,245 ]
= 3.05 years

*THE INTERNAL RATE OF RETURN ( IRR)

-It is the discount rate that sets NPV to zero.
-Minimum acceptance criteria: accept if the IRR exceed the required return
-Ranking criteria: select alternative with the higher IRR.
-Reinvested Assumption: all future cash flows assumed reinvested at the IRR. IRR
may not give the same ranking as NPV at all time.
-Accept the project if the IRR is greater than the discount rate.
 Year 1 2 3 4
270,568,00 288,291,4 307,177,73 327,303,1
Sale revenue
0 91 7 39
148,064,00 157,842,0 168,266,74 179,381,0
Variable cost
0 06 7 65
39,200,00 28,000,00 20,000,00
Dep 22,880,000
0 0 0
91,249,48 110,910,99 127,922,0
Income 99,624,000
5 0 74
36,499,79 44,364,39 51,168,83
Taxes 39,849,600
4 6 0
54,749,69 66,546,59 76,753,24
Incom After Taxes 59,774,400
1 4 5

Internal rate of return IRR will be :

(-160,000,000) + 59,774,400/1 + IRR + 54,749,691/(1+IRR)2 +
66,546,594/(1+IRR)3 + 76,753,242 /(1+IRR)4 = 0
=>IRR=21,05 %
=>IRR > r
Comment: As the IRR is bigger than the discount rate (13.4%). The
project should be undertaken

PROFITABILITY INDEX ( PI)

Total present value of project inflows divided by the initial investment.
Ranking criteria: select project with the highest PI
Minimum acceptance criteria: Accept if PI > 1, NPV> 0

Profitabilit
y index
51,764,63 47,413,23 57,629,35
Discounted cash 66,468,310
0 2 0
Total discounted 223,275,5
cash 23
160,000,0
Initial invesment
00

Profitability index will be :

 =223,275,523 / 160,000,000
= 1.4 >1
Comments: As the PI of the project is bigger than 1, the project will be
acceptable.
 
*FINDING

Results
Net present value 27,333,525
Payback period 2.7 years
Discounted payback period 3.05 years
IRR 21.05 %
PI 1.4

=> As a result, we should accept the project.