A toy maker is considering whether to launch a new robotic dinosaur. Production requires an initial investment of £50m in year 0. The project is expected to be operational in years 1-3. In year 4, it will be possible to recover £10m of the initial investment by converting production facilities. Sales of the toy robot are expected to be £30m in year 1, £40m in year 2, and £50m in year 3. Operating costs are assumed to be £15m in each of years 1-3. The value of goods in the inventory in each of years 1-3 is estimated to be equal to 10% of the value of sales. The accumulated inventory will be entirely sold in year 4. Assume for simplicity that all cash flows (including working capital investments) occur at the end of the year. Assume also no taxes, a 3% risk free rate, a 6% market risk premium, and that the toy maker's equity has a beta equal to 1.5.
a) Assuming that the toy maker is 100% equity financed, determine the
b) Assume now that the toy maker has a debt to equity ratio equal to one. The yield to maturity on the company's bonds is 6%. Determine the NPV of the project with the new data.
c) Everything is as in b), but you are told that the toy maker is currently selling a model of robotic alien. The alien is quite popular and sales are expected to be equal to £20m in year 1, £22m in year 2, and £22m in year 3. However, if the company launches the new robotic dinosaur, sales of the robotic alien are expected to decline by half in each year. Is this piece of information relevant for the evaluation of the project? If yes, then is the project profitable? Give reasons for your answer.
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