Crest Concrete Inc. has been building basements and slab foundations for new homes in La Crosse, Wisconsin for more than 20 years. However, new home sales have slowed recently and residential construction work is hard to get. As a result, management is considering a venture into commercial construction. Although Crest would still be pouring concrete in commercial building, almost everything else about the business differs substantially from homebuilding which is all the firm has done until now.
The local commercial concrete business is dominated by two firms. Readi-Mix Inc., and Toddy Concrete Inc. Readi-Mix has been in business for 50 years, has a market share of 70%, and a beta of 1.3. Toddy has been in the area for only five years and has a beta of 2.4. Crest’s own beta is .9 and its cost of capital is 9.3%. Both of these were developed during a long period in which the housing market was prosperous and growing steadily. The stock market is currently returning 11% and treasury bills are yielding 4.2%
Crest will have to spend $950,000 to get started in the commercial field, and expects net cash inflows of $250,000 in the first year, $400,000 in the second year and $700,000 in the third.
Should Crest give commercial construction a try?