(Project Free Cash Flows & NPV/IRR). (85 points). Solve the…
(Project Free Cash Flows & NPV/IRR). (85 points). Solve the following project free cash flow problem: Gridiron Helmet Company (GHC), a manufacturer of football helmets, is concerned about concussions in football and is considering a new project involving the introduction of a new product line of helmets they plan to call the Shield. This new project is expected to last four years, and then, due to the fact that technology is changing rapidly in this area, it is expected to be terminated at such time. The cost of new equipment required for the new product (the Shield) is $18,500,000. Shipping and training expenses for the new equipment are $225,000. The company has already incurred $1,725,000 for research & development costs related to the new helmet design and will need to spend an additional $350,000 before launch of the product to complete the design work. Additionally, the company expects to incur $285,000 for product safety certification costs prior to the introduction of the new product (the Shield) and these certification costs are directly related to the introduction of this new football helmet. Unit sales of the new product (the Shield) are expected to be: 95,000, 115,000, 110,000 and 75,000, respectively for years 1 thru 4. Average sales price per unit of the new product (the Shield) is expected to be $300 in year 1 and drop by 5% each year for years 2 thru 4. Average variable costs per unit for the new product (the Shield) are anticipated to be $195 in year 1 and grow at inflation thereafter. Fixed operating costs for the new product (the Shield) are estimated to be $2,125,000 in year 1 and grow at inflation thereafter. To market the new helmet GHC will increase its marketing costs to $1,450,000 starting in year 1 from its current level of $1,200,000 and hold to the same amounts for years 2 thru 4. GHC also expects to use a vacant building it owns for manufacturing of the new product (the Shield). The building manager at GHC has found another company to lease the space for $275,000 per year in the event GHC does not need the space for the new Shield product. The marketing efforts related to the introduction of the new product (the Shield) are expected to increase the unit sales of one of the company’s existing football helmet product lines (the Protector) by 6,000, 8,000, 5,000 and 2,000 units, respectively in years 1 thru 4. Average sales price per unit of this existing product (the Protector) is expected to be $280 in years 1 & 2, $260 for year 3 and $225 for year 4. Average variable unit costs for the existing product (the Protector) are expected to be $175 per unit in year 1 and grow at inflation thereafter. In order to determine the initial working capital requirement to get production of the new product (the Shield) started, the company has determined this project will cause the following changes: Without the Project With the Project Accounts Receivable $1,150,000 $1,275,000 Inventory $2,475,000 $2,925,000 Accounts Payable $950,000 $1,075,000 Thereafter starting in year 1, the total investment in working capital is expected to equal 7 percent of the relevant sales dollars for each year. All working capital should be assumed to be liquidated at the termination of the project at the end of year 4. Interest payments and other financing costs to support the new product (the Shield) are expected to be $1,800,000 annually for years 1 thru 4. The straight-line depreciation method over a four-year period with no salvage value should be assumed. The inflation rate should be assumed to be 2.9% per year. The company’s tax rate is 27%. Given the above information, determine the annual (Year 0 thru Year 4) incremental free cash flows associated with this potential new project. Also, calculate the NPV, IRR and Payback Period for this project and indicate for each decision tool result whether the project should be accepted or rejected. Use a WACC of 10% for the discount rate. Also note the company requires a 4.0-year maximum payback period for new projects.