the payment period to wholesale customers is extended from 30 to 60 days, together with other marketing
Question:
the payment period to wholesale customers is extended from 30
to 60 days, together with other marketing strategies, leading to (forecasted) increase
in sales of 21,900 bikes per year. While the bikes are selling at $620/unit on average,
DuraBike can purchase its material from its supplier at $300/bike and is liable to pay
its supplier in 60 days on average. Manufacturing and selling the bikes takes a total
of 25 days on average. To accommodate the increase in demand due to the campaign,
DuraBike would need to buy new machines costing $16,000,000 today, with a
lifetime of 10 years (assume straight-line depreciation and 'zero' salvage value).
Moreover, the marketing campaign will involve a cash cost of $4,000,000 per year.
As per the above forecasts and assume they remain the same every year, this 10-year
campaign will be able to generate free cash flows of $2,585,600 per year (ignored the
change in working capital). DuraBike currently has 80% equity and 20% debt in the
balance sheet. Regarding the equity, DuraBike's shares have a beta coefficient of 1.4,
while the risk-free rate is 2.5% and the expected return on market portfolio is 8.5%.
On the liability side, DuraBike is paying an average before-tax interest rate of 8% per
annum on its borrowings (the tax-rate in the U.S. is 30%).