OMEGA TYRES, plc$.$

After extensive research and development, Omega Tyres, plc$.,$ has recently developed a new tyre, the Superduper, and must decide whether to make the investment necessary to produce and market it$.$ The tyre would be ideal for motor$-$car drivers doing a large amount of wet weather and off$-$road driving in addition to normal highway usage.

The research and development costs so far have totalled about $10$ million. Superduper would be put on the market at the beginning of this year, and it is expected to stay on the market for a total of four years. Marketing research, costing $5$ million, has shown that there is a significant market for a$,$ Superduper type tyre.

As a financial analyst at Omega Tyres, you have been asked by your CFO, to evaluate the Superduper project and provide a recommendation on whether to go ahead with the investment. Except for the initial investment that will occur immediately, assume all cash flows will occur at year$-$end.

Omega Tyres must initially invest $120$ million in production equipment to make the Superduper. This equipment can be sold for $51$ million at the end of four years. Omega Tyres intends to sell the Superduper tyre to two distinct markets:

The original equipment manufacturer $($OEM$)$ market:

The OEM market consists primarily of the large motor vehicle manufacturers that buy tyres for new cars. Automotive industry analysts expect motor vehicle manufacturers $($in total$)$ to produce and sell $2$ million new cars this year and production and sales to grow at $2\mathrm{.}5\%$ per year thereafter. Each new car needs four tyres $($the spare tyres are undersized and are in a different category$).$ Omega Tyres expects Superduper to capture $10\%$ of the OEM market.

In the OEM market, the Superduper product is expected to sell for $36$ per tire. The variable cost to produce each tyre is $18.$

The replacement market:

The replacement market consists of all tyres purchased after the motor$-$car has left the factory. Industry analysts estimate that the replacement tyre market size will be $14$ million tyres this year and that it will grow at $2\%$ annually. Omega expects Superduper to capture an $8\%$ market share.

This market allows higher margins; Omega Tyres expects to sell Superduper for $60$ per tyre there. Variable costs are the same as in the OEM market.

Omega intends to set their annual selling prices $($from next year$)$ with a $4\%$ increase each year; variable costs are also expected to increase annually $($from next year$)$ by $4\%.$ In addition, the Superduper project will incur $25$ million in marketing and general administration costs the first year. This cost is expected to increase by $3\%$ in the subsequent years.

The immediate initial working capital requirement is $11$ million. Thereafter, the net working capital requirements will be set as the difference $($in monetary value$)$ of two consecutive years' $15\%$ of planned sales. For year $1$ it will be the difference between the initial working capital requirements of Year $0$ and the first year's $15\%$ of sales. Assume that the total working capital requirements from year $0$ to year $3$ will be recovered in the terminal year.

Assume Omega's corporate tax rate is $40\%.$ Further assume that it depreciates the equipment at $20\%$ per annum using the straight line method.

The company uses a $16\%$ discount rate to evaluate new product decisions.

Required:

Using the payback, discounted payback and NPV methods determine whether the project should be accepted or rejected.

Comment on the results in regards to the factors that may be considered in terms of revising the assumptions and projections of the project.

You may provide specific alternative scenarios to support your position.