You run a profitable conglomerate that is considering a ten-year investment into the $1 billion (annual revenue) gelato market. You spent $2 million to obtain the following data. You believe you can lever your business to instantaneously capture 4% market share. However, you generate food sales that this project will cannibalize by 10%. On the other hand, you will realize synergies resulting in your other sales increasing by 20% as opposed to the $10 million increase currently expected. COGS are always 40% across all businesses and NWC is always 10% of Sales. Note that all annual figures occur at year end and are flat over the ten year life of your investment while immediate costs occur at time 0. In order to achieve these figures, you will need to invest $80 Million up-front in equipment. You can expense 12.5% of this and capitalize the rest which will be straight-line depreciated over the ten year time frame of this project. This is on top of the $20 million spent on land last year ago for this project that would now fetch only $15 million on the market due to a recent downturn in housing in land values. If you cancel the project, there is no use for this land. Maintenance and other expenses associated with this land will be $2 million per year. There is an additional operating expense of $5 million annually. And, headquarters plans to charge a $5 million overhead allocation where 40% of this is fixed and the remainder variable. These numbers are the expected figures for each year throughout the 10 year life of the project. After the tenth year, you believe you can sell the business with its assets for $25 million. The IRS assigns a Corporate Tax Rate of 20%. Market Risk Premium is 6. You also have the following financial data: Treasury Security Rate 3-month T-bill 3% 10-year T-bond 5% 30-year T-bond 6% AA Corporate Bonds 8% A Corporate Bonds 9% Your Firm Figo Gelati Anita Gelato Total Sales $250 Million $70 Million $60 Million Gelati Sales $0 $68 Million $59 Million Food Sales (all food) $100 Million $68 Million $59 Million Bond Credit Rating AA AA AA Beta (Yahoo Finance) 1.2 0.9 1.0 Total Book Capitalization $600 Million $100 Million $80 Million Leverage Ratio (Book) 25% 20% 25% Stock Price (Book) $45 $8 $6 Stock Price (Market) $60 $12 $10 Given an appropriately borrowed $25 million at your current bond rating to fund this project, show whether you should invest using DCF analysis and what your new stock price is expected to be if you were to do it.
You run a profitable conglomerate that is considering a ten-year investment into the $1 billion (annual revenue) gelato market. You spent $2 million to obtain the following data. You believe you can lever your business to instantaneously capture 4% market share.
However, you generate food sales that this project will cannibalize by 10%. On the other hand, you will realize synergies resulting in your other sales increasing by 20% as opposed to the $10 million increase currently expected. COGS are always 40% across all businesses and NWC is always 10% of Sales. Note that all annual figures occur at year end and are flat over the ten year life of your investment while immediate costs occur at time 0. In order to achieve these figures, you will need to invest $80 Million up-front in equipment. You can expense 12.5% of this and capitalize the rest which will be straight-line
You also have the following financial data:
Treasury
Security Rate
3-month T-bill 3%
10-year T-bond 5%
30-year T-bond 6%
AA Corporate Bonds 8%
A Corporate Bonds 9%
Your Firm Figo Gelati Anita Gelato
Total Sales $250 Million $70 Million $60 Million
Gelati Sales $0 $68 Million $59 Million
Food Sales (all food) $100 Million $68 Million $59 Million
Bond Credit Rating AA AA AA
Beta (Yahoo Finance) 1.2 0.9 1.0
Total Book Capitalization $600 Million $100 Million $80 Million
Leverage Ratio (Book) 25% 20% 25%
Stock Price (Book) $45 $8 $6
Stock Price (Market) $60 $12 $10
Given an appropriately borrowed $25 million at your current bond rating to fund this project, show whether you should invest using DCF analysis and what your new stock price is expected to be if you were to do it.
Step by step
Solved in 2 steps
