Evaluate the fluff as a business opportunity

Reference no: EM132753377

Question: You are considering the purchase of a new fluff fabricating machine for your firm, Winter Co. The purchase of the fluff will allow WC to market a new product, a pillow with built-in scents. In order to analyze the decisions to manufacture and sell the pillows and to lease the fluff, you have collected the following data, some of which may be relevant (all dollars in 2020 prices):

Cost of fluff = $9,500,000

Useful life of fluff = 10 years

Salvage value of fluff = $0

Expected pillows sales volume (in lots of 1000) = 2500/year

Wholesale price per 1000 lot of pillows= $999

Annual fluff maintenance contract costs (no inflation) = $100,000 (only cash fixed cost)

Average variable cost per lot of pillows = $500

Additional working capital (supplies inventory) required at beginning of year 1 = $150,000

Current equity = $55,000,000

Current debt = $60,000,000

Tax rate for CEI = 35%

Inflation rate = .03

Fluff can be financed in several ways. The following data pertain to financing options:

Required return on equity (real) = .06

Bank loan interest rate available, given current capital structure = .085

Lease contract with payments made in 10 equal annual installments, beginning at start of lease period. Lease contract includes maintenance costs. Payment = $1,150,000

Evaluate the fluff as a business opportunity for WC and show your formuals. Should WC acquire the use of the fluff? Should WC lease the fluff, if it decides to acquire it? Evaluate the lease financing option for the zippy as well. Lets value the financial lease and assume that the change in the tax code in 2017 has expired (as it is claimed to do). Therefore, spread depreciation expense out over the life of the assets on a straight-line basis.

Reference no: EM132753377

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