W & T Racket designs is the leading racquet company. They are known for their innovation of new technology for racquet sports. W & T is planning on implementing a new racquet into production to replace their old tour model racquet. The old model was very popular with most customers, but W & T wants to implement new technology to improve this model. The company tries to produce a new racquet every 3-8 years to try and lead industry standards. When a new racquet design is introduced, the company must invest in a new mold which includes updating the exisiting machinery.
The company has invested roughly $1 million into research and development of the new technology. The new technology implmented will be called flex-braid. Flex-Braid uses a combination of graphite, carbon, and other composite woven together to form the frame of the racquet. W & T expects to flex-braid to give the racquet more rigidity and also increases feel and control, which is what most of their clientele want.
The mold for the old racquet was produced 3 years ago at a cost of $150,000. Shipping on the old mold was $5,000. In addition, W&T incurred a set-up fee of $20,000. If the old raquet is not replaced, management estimates variable costs of $55 per racquet, fixed costs of $50,000 annually, and production capacity of 12,000 racquets annually over the the next 5 years. In addition, W&T currently has an offer of $20,000 for the old mold. If not replaced, it is estimated that the old mold will only sell for $12,000 5 years from today. For this reason, the old mold is being depreciated on a straight-line basis to a book value of $12,000 over 8 years. THe companys marginal tax rate is 35%, and its cost of capital 15%. This project is eqaually as risky as a typical company project. Therefore, the required return on this project is equal to the company's cost of capital.
The question that has risen us what type of mold should be used to produce the new raxquet? Due to the racquets ,aterial, the old mold will not be suffecient. Due to the differing qualities in the potential new molds, the revenues, expenses, initial investments, and future market valuer of the new molds can vary tremendssly. W&T has serveral options for the new mold.
One option that W & T can use is:
The cost of this mold will be $496,996. Due to the distance from the factory, shipping on this mold will be $8,821, and installation will be $31,348. It is estimated that variable production costs on this new mold will be $55 per racquet, fixed cost of $62,363 annually, and a production capacity of 12,234 racquets annually over the next 5 years. If this mold is selected, the racquet is expected to sell for $134. Sales on W & T's existing racquets are excpected to fall by $5,000 annually over the next 5 years with the introduction of this top notch racquet. The accounting department has informed you that this mold will depreciate using a 5-year MACRS depreciation schedule. It is expected that this mold will be sold at the end of 5 years for $32,848. In addition, if this mold is selected the level of inventory on hand is expected to rise by $7,442, the level of supplies on hand is expected to decrease by $840, and $1,900 of the inventory can be financed through the supplier with an increase in accounts payable.
1. Calculate the estimated Net Initial Investment and estimated incremental cash flows for the next 5 years if the existing mold is replaced with this new mold.
2. Calculate NPV, IRR, payback, discounted payback, and profitability index for your project.