ECR Corporation, a maker of sports accessories, is considering investing in a new project that manufactures tennis
Question:
ECR Corporation, a maker of sports accessories, is considering investing in a new project that manufactures tennis racquets. You have received the following information relating to the project:
• The project will run for four years;
• Annual sales are expected to be $20 million in the first year, and will grow at a rate of 10% until the end of the life of the project;
• Manufacturing costs and operating expenses are expected to be $12 million and $4 million per year, respectively;
• There will be upfront marketing and R&D expenses of $5 million;
• Initial equipment costs of $10 million. The equipment will be depreciated via the straight-line method to a book value of zero over the four years' life. However, at the end of the project, they will receive $800,000 for the equipment;
• Assume that the project has the same risk as the firm. ECR Corporation has $30 million in cash, $300 million in equity, and $330 million in debt. ECR's debt cost of capital is 7%, and the cost of equity capital is 12%;
• ECR Corp pays a corporate tax rate of 35%;
• In addition, you have been told that no net working capital is required for the project;
• Assume all cash flow occurs at the end of the year.
Questions:
a) For each year, calculate the projected free cash flows of the new project.
b) Assuming ECR Corporation wishes to constantly maintain a target leverage ratio; calculate the unlevered cost of capital and the weighted average cost of capital.
c) Calculate the levered value of the project.
d) What is the debt capacity of the project for each year?
Management Accounting Information for Decision-Making and Strategy Execution
ISBN: 978-0137024971
6th Edition
Authors: Anthony A. Atkinson, Robert S. Kaplan, Ella Mae Matsumura, S. Mark Young