You were hired as a financial consultant for David & Main Co. which is a publicly traded company that produces luxury watches. The company considers starting a new production line, sport watches, and they need to raise $300 million to fund the new project. Of the $300 million, $200 million will be invested in purchasing a new equipment to manufacture the watches with a lifetime of 5 years. This equipment is three-year MACRS property for tax purposes and the salvage in 5 years is zero (zero at year 5).

In addition, the company will have to invest the remaining $100 million in net working capital at the beginning. The company believes that they can annually sell around 10,000 sport watches at a price of $25,000 per unit, which cost them only $10,000. Fixed costs for the project will run $1,000,000 per year.

The company’s capital structure calls for 60% debt and 40% equity from retained earnings. The company has an outstanding 25 years noncallable bond with a face value of $1,000 and 10% annual coupon rate. The market price for the bond is $1,100 and tax rate is 35%. The company’s historical stock prices along with the market portfolio (the index) are attached. If you have the following information:

The return on the market portfolio “index” (R_m) = 8%

The risk-free rate = 2%

Growth rate = 10%

Dividend paid last week = $4

Company’s risk premium = 4% (NOT CAMP RP)

1. What recommendation would give the management of David & Main Co.? Should they accept the proposed business line (Sport Watches)? Use NPV, IRR, MIRR, Payback Period, and Discounted Payback Period to support your answer.

2. The management of David & Main Co. reviewed your decision, but they have some concerns about sales due to COVID – 19. They explain that due to the pandemic and curfew, sales may not be as expected (might do down) and may not be able to sell 10,000 units. On the other hand, they are now working on improving their online website hoping the increase sales. Thus, they want to know how your decision is sensitive to changes is sales units if they believe that they would sell 8,000 units in the worst-case scenario and 12,000 unit in the best-case scenario. Would you still give David & Main Co. the same decision you gave earlier? explain