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Assignment 2: Final Project: Part 3

Final Project Scenario

You are an economist for the
Vanda-Laye Corporation, which produces and distributes outdoor cooking
supplies. The company has come under new ownership and management and will be
undergoing changes in its product lines and operating structure. As an
economist, your responsibilities include examining the market factors that
affect success or failure of a product, including the supply and demand for the
product, market conditions, and the behavior of competitors with similar
products.

The new management has identified
several possible investments for the coming year. It has asked you and your
team to evaluate the possibilities and make a recommendation to the board of
directors. Jorge has identified two mutually exclusive opportunities
(Investment A) and two independent opportunities (Investment B) and assigned
you the task of making a recommendation on the investments.

Investment A

Your company would like to increase
its product lines. Two alternatives are available, a new line of outdoor
smokers and a new line of outdoor grills. The two lines are mutually exclusive,
meaning that only one of these investment alternatives can be selected. The
projected cash flows and their respective probabilities for each alternative
are given in the table. There are three possible levels of demand and their
corresponding probabilities, which depend on the state of the economy.

Click here to download the table for Investment A.

The two alternatives carry equal
risk and should be evaluated at the company’s cost of capital. The cost for the
new smoker line will be $7,000,000. Also, the company has been guaranteed a
buyer for the new line at the end of the fifth year. The buyer has agreed to
purchase the new line for $7,900,000. The outdoor grill alternative will cost
$3,987,000 and also has a guaranteed buyer, who has agreed to pay $4,000,000 at
the end of the fifth year.

Investment B

Investment B involves two
independent investment opportunities. The decisions on these two investment
alternatives are also independent of Investment A. Investment B-1 involves a
new packaging machine, which will eliminate the need for a local firm for
packaging Vanda-Laye’s products. The cost of this machine will be $24,000, and
the expected revenues from this opportunity are given in the table and are
considered to be of average risk. Investment B-2 is the purchase of a new
computer system that will allow the company to sell its products on the
Internet worldwide. The cost of this new system will be $29,000, with the expected
cash flows after taxes given in the table.

Click here to download the table for Investment B.

Jorge has asked you to provide
detailed responses to the following:

  • Management of Vanda-Laye has determined that the
    capital structure of the company will involve 30% debt and 70% common
    equity. This structure will be used to finance all investments by the
    company. Currently, the company can sell new bonds at par, with a coupon
    rate of 7%. Any new common stock can be sold for $45, with a required
    return (or cost) of 15.57%. Using Microsoft Excel, calculate the company’s
    cost of capital to be used in the evaluation of possible investment
    projects.
  • For Investment A:
    • Using Microsoft Excel, create a decision tree.
      Indicate the various levels of demand and their respective probabilities.
      Also, include the calculations for the expected cash flows.
    • Calculate the expected NPV for each alternative.
      Explain the decision rules for making a selection between the two
      alternatives on the basis of the expected NPV.
    • Assuming the two alternatives are mutually exclusive,
      specify which alternative you would recommend to the company. Explain
      why.
    • If the two alternatives were independent of each
      other, specify which project you would select. Would you accept both
      projects if funding were available for both? Explain your answer.
  • For Investment B:
    • Using Microsoft Excel, calculate the NPV for each
      alternative.
    • Using the decision-making criteria for the NPV,
      specify which alternative you would select if the two alternatives were
      mutually exclusive. Explain your answer.
    • Given that the two alternatives are independent of
      each other, specify which investment you would select, if not both.
      Explain your answer.
    • Using Microsoft Excel, calculate the IRR for each
      investment.
    • Using the decision-making criteria for the IRR,
      specify which alternative you would prefer. Explain your answer.
    • If funding were available, specify whether you would
      select both investments. Why or why not?
    • Calculate the profitability index (PI) for the two
      investments. Which project is preferred?
    • Determine whether there is a ranking conflict present
      in terms of the IRR and the NPV. Explain your answer. If a conflict does
      exist, explain how you would resolve the situation.

Submission Details:

  • Compile a report including all your responses from Weeks
    1
    , 3, and 5. Make sure your report reads as one report
    rather than three reports pasted together. Complete all revisions
    suggested by your instructor in previous weeks. Make sure all responses
    are complete and accurate, supported by references and documented
    examples. The report should be 10–15 pages in length and include an
    executive summary.
  • Name the spreadsheet as
    SU_MBA5004_W5_A2_LastName_FirstInitial.xls and your Microsoft Word
    document as SU_MBA5004_W5_A2_LastName_FirstInitial.doc.
  • By Tuesday, May 3, 2016, submit these documents
    to the W5 Assignment 2 Dropbox.

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