Reference no: EM133084817

Question - IMI has been exploring some growth opportunities. One opportunity that looks promising is a new factory that can produce battery operated Sports Utility Vehicles or SUV's. SUVs are currently very popular with young families and the demographic is expected to continue to grow. The problem is that many consumers are not convinced a battery alone will provide the sufficient mileage and would prefer a hybrid of gas/battery. A plant and ware-house, complete with equipment, that could produce hybrid SUV's is expected to cost $12.5M. All factory and equipment costs have a CCA depreciation rate of 20% and an expected salvage value of $2.17M at the end of the project's life in 8 years. The tax rate is assumed to stay constant at 35%.

Hybrid SUV's sell for $60,000 with a production cost of $50,000. Fixed costs are expected to be $1,500,000 annually. Net working capital is expected to be $20% of the expected growth in sales for the next year. IMI expects the project to recover its net working capital in the last year. IMI expects to be able to produce and sell 525 SUV's a year and expects unit sales to increase by 10% per year after the first year.

At a board meeting, the VP of Marketing indicates that the company spent $150,000 on a marketing study that determined the expected future care sales. The VP of Operations mentions that IMI owns an empty warehouse that is currently on the market for $1,200,000. Instead of selling it, it could easily be converted to a new plant, saving the project money.

Use a WACC of 13% for your calculations going forward.

a. How should the $150,000 marketing study be addressed in your valuation?

b. Should the $1,200,000 warehouse mentioned by the VP be considered a reduction in the initial investment? Explain.

c. What is the NPV of the hybrid plant?

d. What is the IRR of the hybrid plant?

e. Should the company invest in a plant to make hybrid SUV's?

f. If the fixed costs, variable costs, sale price and unit sale growth rate are considered to be accurate within 15%, what are the best- and worst-case scenarios?

g. What variable(s) would this project be most sensitive to and what are some suggestions you might have for the IMI to protect itself?