You are a project manager at the Joe&Bernie Shoe Company (JBSC), which sells sneakers to elderly men who still enjoy running despite their advanced age. Your task is to assess the financial viability of a new shoe line that JBSC is considering launching. You have the following information:

 

The project lasts 5 years.

Today, an initial investment of $10 million is required. The investment will be depreciated linearly over the project lifecycle, with zero salvage value.

Over the whole project period, you expect the sales price to remain constant at $75 per pair of sneakers. Also production costs are expected to remain constant at $40 per pair.

The sales department reports the following expected revenues:

In addition to the production costs outlined above, you expect that the new shoe line will trigger selling, general and administrative expenses of $1 million per year.

The project takes place in the U.S. and the relevant tax rate is 21%.

Moreover, the project does not require any working capital.

The appropriate market risk-adjusted WACC for the project is 15%.

The patent of the sneaker's innovative sole is owned by a subsidiary of JBSC's that is located in Jersey and operates at a tax rate of 5%. For each pair of shoes sold, the Jersey subsidiary charges royalties of $15. In the Jersey subsidiary, there are no actual services provided or direct costs associated with the royalty payments.

Finally, you learn that the Senior Citizen Super Pac (SCSP) is eager to support your project with an interest-free loan of $1 million. A normal market interest rate for such a loan is 10%. Consequently, each year, this non-market financing opportunity allows you to save $100'000 in interest expenses. Given the tax rate of 21%, the after-tax interest savings of the loan, therefore, are $79'000. You assume that the appropriate discount rate for these interest savings is the fair market rate of the loan, i.e., 10%.

Based on all this information, compile a valuation for the project. Make sure to the various sources of value in a transparent way. What should JBSC do?

 

Transcribed Image Text:

Sales price ($ per pair) Pairs sold (thousands) Total revenues (thousands) Year 1 75 100 7,500 Year 2 75 150 11,250 Year 3 75 120 9,000 Year 4 75 100 7,500 Year 5 75 80 6,000 Sales price ($ per pair) Pairs sold (thousands) Total revenues (thousands) Year 1 75 100 7,500 Year 2 75 150 11,250 Year 3 75 120 9,000 Year 4 75 100 7,500 Year 5 75 80 6,000

Answer rating: 100% (QA)

Here is the financial analysis of the new shoe line project Cash Flows Year 1 Revenue 7500 pairs 75 ... View the full answer