XYZ Inc. is a telecom company for phone products and services that is studying a 10 year investment opportunity. XYZ Inc. has just conducted a $20 million feasibility study that considers introducing a new line of products, that will include 5G enabled devices. To do so, XYZ Inc. will need to invest in technology and equipment of $48 million. In addition, they will require development expenses that have to be paid upfront. Precisely, a sum of $5.5 million for R&D and $3.5 million for marketing expenses. During the first 4 years, the marketing group expects annual sales to grow my 4 percent. They forecast the initial year to witness $110 million in sales. However, after the fourth year, they expect sales to drop by 7% annually due to 5G network changes and modifications. Hence, it expects to acquire additional equipment’s with an expense of $30 million for its products with the expected change of the network.
The costs of manufacturing these products are expected to be $50 million in the initial year with a 5% expected annual increase for the first four years and a 8% increase afterwards. Operating expenses are expected to be $9.5 million per year. Net working capital is predicted to be 20% of manufacturing costs. The company pays a corporate tax rate of 20% and follows a straight-line depreciation method.
XYZ Inc. current Market Balance sheet and Cost of Capital is as follows:
Assets
Cash 100 Debt 400 Debt 6%
inventory 300 Equity 600 Equity 10%
LT Asset 600 Total A 1000
Considering that XYZ Inc. maintains a constant debt to equity ratio, using excel prepare the following:
A- Generate the forecasted incremental earnings statements for this project and estimate the free cash flow statement.
B- Evaluate the project using two capital budgeting methods. C- If the firm follows the Marcs 10-year depreciation method, will the decision change?