You have been hired to assist Bill and Ted’s Inc. (BTI), a large, publicly traded company that produces excellent guitars.

The company plans to set up a new facility in Kazakhstan to produce violins for clientele in Europe and Asia. The project is expected to last five years. The company is going to build this facility on land it purchased three years ago for $4 million. The land was appraised last week; the cost of the appraisal was $10,000, and the land value was deemed to be $5.1 million. The company anticipates that this will increase in value to $6 million by the end of the project. The company does not anticipate that it will sell the land but will use if for other purposes at the end of this project.

The plant and equipment are expected to have a total cost of $35 million and is in the 7-year useful life category for MACRS with no salvage value. At the end of the project, the company anticipates that the value of the plant and equipment will be $5 million.

The company will also need working capital to support operations. It will initially need raw materials and operating capital of $15 million. After the initial injection, it will need to keep balances that support the income statement as follows, considering a 360-day year and an even sales cycle:

• Inventory at the beginning of each year to support 15% of that year’s Variable Costs (cost of goods sold)

• Prepaid expenses at the beginning of the year to support 2% of upcoming Revenues

• Accounts Receivable will have an average collection period of 30 days, so at the end of the year, there will be 30 days of accounts receivable outstanding.

• Accounts Payable will be paid on average in 15 days and is related to the variable costs.

• Accruals at the end of each year will be 7% of that year’s variable and fixed costs.

• All of the working capital accounts will be closed out at the end of the 5th year.

The company currently has 240,000 bonds outstanding with a 7.5% coupon rate, 20 years left to maturity that are selling at 94%. These bonds have a $1,000 par value and make semi-annual payments.

The company’s common stock is selling for $71, and there are 9 million shares outstanding. The beta for the common equity is 1.2. The company has 400,000 shares of 5.5%, $100 par value preferred stock that are currently trading at $81 per share. The market premium is currently estimated to be 5%, long-term Treasuries are trading at 3.25%, and the company has a tax rate of 21%.

Because of the additional risk of managing the facility in Kazakhstan, the company policy is to add the country risk premium to its WACC of 3%. BTI intends to manufacture and sell between 8,000 and 12,000 violins each year and to sell them for $12,000 each in the first year; it expects to increase the price each year by 5% after the 1st year. It expects variable costs to be between 75% and 85% of revenues.

The company’s fixed costs will be $10 million in the first year, and will grow at inflation of 5%.

The CFO has asked that you complete the analysis of this project and provide her with an IRR and NPV of this project.

• You initially need to find the NPV and IRR as these are typical metrics that BTI uses for assessing projects.

• You know that, in order to thoroughly examine this problem, you should:

a. Complete a sensitivity analysis around # of units and variable costs.

b. Do a breakeven for number of units if variable costs are 80%.

What will you tell the CFO? Should the company take on this project and why?

Answer rating: 100% (QA)

To calculate the NPV and IRR of the project we need to gather the key information Initial investment Land 4 million Plant and equipment 35 million Working capital 15 million Total initial investment 5... View the full answer