You have just graduated from university and are considering starting a new line clothing.  

To start the new line of clothing you require a capital outlay of $25,000 and net working capital of $1,000.

The new line will sell for $18.99 per unit.  Sales in year 1 are estimated to be 500 units.  You have determined that sales will rise by 20% annually after year 1.  Direct materials costs are estimated to be 20% of annual sales and direct labour costs 10% of annual sales.  

Fixed costs for the new business will be $2,000 annually.  Your old product line will more than likely experience a drop in sales by $500 annually over the first four years of operating the new product line. 

You started the business a few years ago, after taking an awesome finance course in university.  At that time your company issued 35,000 common shares which currently trade at $1.50 per share on the web site InvestO'Rama.com.  They have a beta 1.50.  Pundits are estimating that the InvestO'Rama.com market will rise by 22% over the next year and that riskless investments will earn an average 10.0%.

Your company recently issued 250 coupon bonds at a price of 120.  The bond's pay a 15% coupon, and have a term to maturity of 3 years

The company's tax rate is 20% and its depreciation rate is 10%.  You also note, the new product line is expected to grow at an annual pace of 4% after year 5.  

 

 

Question(s):

1. Would you recommend management accept this new project? Justify your answer using two measures of return. 
2. Which project variable is most likely to cause a loss if business and (or) economic conditions change? Which project variable is least likely to cause a loss if business and (or) economic conditions change? Justify your answers. 
3. What is this project's break-even demand?  Explain your break-even. 
4. What is this project's break-even sales?  Explain your break-even.
5. Management is worried that interest rates might begin to fall.  What bond-risk management strategy could be used to hedge against a drop in interest rates? 
6. Management wants to finance the new product line with both equity and bonds.  If management wants to preserve cash in order to grow the new product line, what type of bond could it issue that would help finance the firm's new product line and eliminate the need for semi-annual coupon payments?