After extensive research and development, Goodwear Tires Inc. has recentlhy deve

Question

After extensive research and development, Goodwear Tires Inc. has recentlhy developed a new tire, the SuperTread, and must decide whether to make the investment necessary to produce and market it. The tire would be ideal for drivers doing a large amount of wet weather and off-road driving in addition to normal highway usage. The research and development costs so far have totalled about $10 million. The SuperTread would be put on the market beginning this year, and Goodwear expects it to stay on the market for a total of four years. Test marketing costing $5 million has shown that there is a significant market for a SuperTread- type tire. As a financial analyst at Goodwear Tires, you have been asked by your CFO to evaluate the SuperTread project and recommend whether to go ahead with the investment. Except for the initial investment, which will occur immediately, assume all cash flows will occur at year-end. Goodwear must initially invest $160 million in production equipment to make the SuperTread. This equipment can be sold for $65 million at the end of four years. Goodwear intends to sell the SuperTread to two distinct markets: 1. The original equipment manufacturer (OEM) market. The OEM market consists primarily of the large automobile companies (like General Motors) that buy tires for new cars. In the OEM market, the SuperTread is expected to sell for $41 per tire. The variable cost to produce each tire is $29 2. The replacement market. The replacement market consists of all tires purchased after the automobile has left the factory. This market allows higher margins; Goodwear expects to sell the SuperTread for $62 per tire there. Variable costs are the same as in the OEM market

Explanation / Answer

Answer:$

Research & Development cost=10 million n=4 years

Test marketing cost=5 million

Initial investment in the Tyre making equipment =160 million equipment can be sold=65 million

Marketing and general administration cost =43 million

OEM markets Replacement market

sell =41 per tyre variable cost=29 Sell=62 per tyre variable cost=29

OEM market share=11% Replacement market size=32 million grow by 2% per annum and Mkt share 8%

Both variable cost and selling price could rise by 1% above inflation

Annual inflation =3.25%

corporate tax rate =40%

Discount rate =13.4%

Production of tyre=62 million

Expected to go=2.5% per annum

CCA rate=25% Initial working capital required =9 million after that 15 days of working capital

All figures in million and in dollars

a) Cash flow from OEM 0 1 2 3 4

34.65 32.71 30.53 28.09

Cashflow from replacement market

88.99 93.78 98.85 104.23

working notes for calculating cash flows:

a)OEM 0 1 2 3 4

Inflation rate 3.25 3.28 3.31 3.34 3.38 Inflation grewing at 1%

Selling price 41 42.34 42.35 42.36 42.38 so does selling price

Variable cost 29 29.95 30.94 31.97 33.05 so does varibale cost

car production 6.2 6.335 6.51 6.67 6.84 grwoing at the rate 2.5%

car tyre production 24.8 25.42 26.05 26.70 27.37 one car has four tyre

Tyre market share 2.78 2.79 2.86 2.93 3.01 11% market share

cash flow(sp-vc)*no of tyre

32.73 34.65 32.71 30.53 28.09

Ditto with Repalcement market

Inflation rate 3.25 3.28 3.31 3.34 3.381

Selling cost 62 64.03 66.15 68.36 70.67

Variable cost 29 29.95 30.94 31.97 33.05

Tyre 32 32.64 33.29 33.95 34.63 growing at 2% annually

Tyre market share 2.56 2.61 2.66 2.71 2.77 Market share at 8%

Cashflow=(S-v)* tyre

84.48 88.99 93.78 98.85 104.23

b) NPV of the project

Initial cash outflow =218

R&d =10

Test marketing cost=5

Production equipment cost=160

Marketing and general management cost=43

Cash inflow present value 0 1 2 3 4   

OEM -32.76 30.55 25.44 20.93 16.9

Repacement market -84.48 78.47 72.97 67.78 63.03

NPV= -cash outflow+ (cashinflow of oem+ cashflow of repalcement)

=-(240+32+84)+(93.92+282.22)

= -356+376

=20

since NPV is positive we should take this project

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.