GameShock Corp. (GSC), an upstart Canadian technology firm, is contemplating the purchase of electronic communications equipment (Hint: Check Canada Revenue Agency website to find which CCA class the equipment belongs to here https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/sole-proprietorships-partnerships/report-business-income-expenses/claiming-capital-cost-allowance/classes-depreciable-property.html) at a cost of $50 million to add to the existing pool of similar equipment. They expect that this equipment will have a useful life of 10 years, at which point they estimate its salvage value to be $5 million.

The new equipment will generate sales of 100,000 units this year, which are expected to increase by 10% per year for the next 3 years, after which the growth rate will decrease by 1% per year (i.e., the growth rate will become 9% in year 4, 8% in year 5 etc.) for the remainder of the life of the project. The price per unit is going to be $100 this year, increasing at a projected rate of 3% per year, and the variable costs are estimated to be at 50% of the sales price. Fixed costs are $1.5 million this year; they are also expected to increase by 3% per year.

It is also expected that the new purchase will require an immediate increase in inventories of $1.5 million, an immediate increase in accounts receivable of $1 million, and an immediate increase in accounts payable of $1.5 million. Subsequently, total net working capital at the end of each year will be 15% of the dollar value of sales for that year. The net working capital amounts will be recaptured at project termination.

It is expected that GSC will finance this purchase with 60% debt and the remainder with equity. As it presently has no debt, it is expecting to offer debt for the duration of the project with a coupon of 3%, and it is projected to sell for 99% of face value. Flotation costs on debt (i.e., costs of issuing debt) are expected to be 2%. It is expected that the additional equity amount will have a systematic risk component based on its exposure to the S&P/TSX index, and that the risk-free rate is expected to be the 3-month T-bill rate, presently at 2% annual. Monthly prices on GSC and the S&P/TSX index are on provided on CULearn in a spreadsheet titled "Final Project Data". Flotation costs on equity are expected to be 2%. GSC's historical earnings are shown in the table below.   

Year

2015

2016

2017

2018

2019

2020

Earnings, mln. $

1.2

1.5

1.6

1.8

1.6

2.0

Currently, GSC has 2 million shares of stock outstanding. It has a tradition of paying 40% of its earnings as dividends. GSC falls into the 30% corporate tax bracket and cannot carry losses forward.

a)What are the cash flows to assets from the project in years 1-10?

Answer rating: 100% (QA)

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