10Games, Inc., is a publicly traded company that makes computer software and accessories. Games's stock price over the last five years is plotted in Figure ST15.1a, Games's earnings per share for the last five years are shown in Figure ST15.1b, and Games's dividends per share for the last five years are shown in Figure ST15.1c. The company currently has 1,000,000 shares outstanding and a long-term debt of $ 12,000,000. The company also paid $1,200,000 in interest expenses last year, has other assets of $5,000,000, and had earnings before taxes of $3,500,000 last year.
Games has decided to manufacture a new product. In order to make the new product, Games will need to invest in a new piece of equipment that costs $10,000,000. The equipment is classified as a seven-year MACRS property and is expected to depreciate 30% per year. Equipment installation will require 20 employees working for two weeks and charging $50 per hour each. Once the equipment has been installed, the facility is expected to remain operational for two years.
Games intends to maintain its current debt-to-equity ratio and therefore plans on borrowing the appropriate amount today to cover the purchase of the equipment. The interest rate on the loan will be equal to its current cost of debt. The loan will require equal annual interest payments over its life (i.e., the loan rate times the principal borrowed for each year). The principal will be repaid in full at the end of year two. Games plans on issuing new stock to cover the equity portion of the investment. The underwriter of the new stock issue charges an 11 % flotation cost.
Games estimates that its new product will acquire 20% of all market share within the United States. Even though this product has never been produced before, Games has identified an older product that should have market attributes similar to those of the new product. The older product's unit market sales for the entire United States for the last five years are shown in Figure ST15.1d. It is estimated that the new product will sell for $20 per unit (in today's dollars). Costs are estimated at 80% of the selling price for the first year and 60% of the selling price for the second year. Inflation is estimated at 10% per annum for the new product.
Due to the large size of the investment required to manufacture the new product, Games's analysts predict that once the decision to accept the project is made, investors will revalue the company's stock price. Because you are the chief engineering economist for Games, you have been requested by upper management to determine how manufacturing this new product will change Games's stock price. Management would like answers to the following questions. (The first three questions are asked in a sequence that will assist you in answering the last two questions.)
(a) Games's investors usually use the corporate value model (CVM) to determine the total market value of the company. In its most basic form, the CVM states that a firm's market value is nothing more than the present value of its expected future net cash flows plus the value of its assets. Using this logic, what must investors currently assess the present value of Games's future net cash flows to be (not including the investment in the new product)?
(b) Determine Games's tax rate.
(c) Determine an appropriate MARR to use in the analysis when the financing source is known. Now do the same when the financing source is unknown.
(d) Assuming that the new-product venture is accepted and the new piece of equipment is disposed of at the end of year two, what is a most-likely estimate for Games's stock price?
(e) Now assume that the new piece of equipment is not disposed of in year two and that Games has not decided how the $ 10,000,000 for the equipment will be financed. Instead, assume that the revenues generated from the new product will continue indefinitely. Estimate a pessimistic, a most-likely, and an optimistic estimate for Games's stock price.

Figure ST15.1a Stock price per share.

Figure ST15.1b Earnings per share.

Figure ST15.1c Dividend per share.

Figure ST15.1d Total unit sales in the United States for the older product.

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Stock Price per Share (5) 20 18 15 12 10 2004 2005 2006 2007 2008 2009 2010 Year Earnings per Share 2.5 2 1.5 2.1 1.7 1.2 E 0.5 0 2004 2005 2006 2007 2008 2009 2010 Year Dividends per Share 1.9 1.5 1.5 1.2 1.1 o.5 2004 2005 2006 7 2008 2009 2010 ear Unit Sales for Older Product 15 10 10 5 2004 2005 2006 2007 2008 2009 2010 Year