Honda is considering producing a new line of compact cars called the H-Mini. The new line will require an initial investment in equipment of $300 million and is expected to generate $600 million in revenues for each of the next 3 years (i.e., t=1, t=2, and t=3). The equipment will be depreciated straight-line to $0 over 3 years. Variable costs are estimated to be 70% of the H-Mini sales. Fixed costs will be $30 million a year. For marketing of the new car, Honda plans to use its existing provider, GSD&M. GSD&M has been under contract to provide all of Honda’s marketing services for the past 3 years at $50 million a year, and Honda & GSD&M agreed last month to another three year contract at the same price, independent of Honda’s decision regarding the new product line. The project will require an investment in inventory. At the beginning of the project (i.e., t=0), $50 million of inventory is required. Thereafter, inventory is projected to remain at $50 million each year (i.e. they make no further additions to inventory) and is recovered fully at the end of the project. At the end of the project (i.e. t=3), the firm will donate (give away)the initial equipment, which will have zero value in the market to them, and no positive or negative tax consequences from the donation. The sale of this new line of cars, however, will reduce sales of the Honda Civic car by $10 million a year. The cost of capital is 10%. The corporate tax rate is 30%. What is the NPV of the project, and should Honda do this project?

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter12: Capital Budgeting: Decision Criteria

Section: Chapter Questions

Problem 16P: Shao Airlines is considering the purchase of two alternative planes. Plane A has an expected life of...

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Honda is considering producing a new line of compact cars called the H-Mini. The new line will require an initial investment in equipment of $300 million and is expected to generate $600 million in revenues for each of the next 3 years (i.e., t=1, t=2, and t=3). The equipment will be depreciated straight-line to $0 over 3 years. Variable costs are estimated to be 70% of the H-Mini sales. Fixed costs will be $30 million a year. For marketing of the new car, Honda plans to use its existing provider, GSD&M. GSD&M has been under contract to provide all of Honda’s marketing services for the past 3 years at $50 million a year, and Honda & GSD&M agreed last month to another three year contract at the same price, independent of Honda’s decision regarding the new product line. The project will require an investment in inventory. At the beginning of the project (i.e., t=0), $50 million of inventory is required. Thereafter, inventory is projected to remain at $50 million each year (i.e. they make no further additions to inventory) and is recovered fully at the end of the project. At the end of the project (i.e. t=3), the firm will donate (give away)the initial equipment, which will have zero value in the market to them, and no positive or negative tax consequences from the donation. The sale of this new line of cars, however, will reduce sales of the Honda Civic car by $10 million a year. The cost of capital is 10%. The corporate tax rate is 30%. What is the NPV of the project, and should Honda do this project? Show your work!

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