George foreman has been selling grills for over 50 years now. The current target debt to value ratio is 35%. It borrows at 8% interest and the tax rate is 40%. At this capital structure, shareholders require a 15% return. They plan to expand production capacity. Equipment that will be purchased costs $40 million today and will last 4 years. Depreciation = straight line with no salvage value. Forecast for the next 4 years (in millions)
|
Year 1 |
Year 2 |
Year 3 |
Year 4 |
| Revenue |
30 |
30 |
30 |
30 |
| Cash Costs |
15 |
15 |
15 |
15 |
| Investment in Working Capital |
2 |
2 |
2 |
2 |
Foreman expects to recover all investment in working capital in year 4. Foreman has arranged $20 million loan for partial expansion funding. The terms are 8% annual on outstanding balance of the beginning of the year. Firm will also make year end principal payments of $5 million per year and completely retire debt at year 4.
Ignoring financial distress and issuing costs, how much value is to be created or destroyed by this project and should they proceed with the project?