In this assignment you take the position of an analyst working within a large clothing designer / manufacturer / retailer. Your company has developed...

In this assignment you take the position of an analyst working within a large clothing designer / manufacturer / retailer. Your company has developed an e-ink usable in cloth and it intends to maintain the recipe and production process as a trade secret. This, combined with the somewhat complicated nature of the technology, requires that rather than outsourcing the production of garments including the technology your firm will be required to manufacture them in house. You are tasked with determining which of three potential geographic locations for the new plant best serve the interests of the firm and its stakeholders or if e-ink products should not be brought to market based on revenue and cost projections. In addition there is potential in some locations to move forward with some of the firm's sustainability agenda and source the power from the plant using wind or solar energy.

You estimate that your product will have a six-year life span, and the equipment used to manufacture the project falls into the MACRS 7-year class. The resulting MACRS depreciation percentages for years 1 through 8, respectively, are 14.29%, 24.49%, 17.49%, 12.49%, 8.93%, 8.92%, 8.93%, and 4.46%. Your venture would require a capital investment of $140,000,000 in equipment, plus $10,000,000 in installation costs. The venture will increase accounts receivable and inventories of $35,000,000. At the end of the six-year life span of the venture, you estimate that the equipment could be sold at a $50,000,000 salvage value. Your venture would incur fixed costs of $10,000,000 per year, while the variable costs of the venture would typically equal 30 percent of revenues depending on the location of the plant. You are projecting that revenues generated by the project would equal $40,000,000 in year 1, $150,000,000 in year 2, $180,000,000 in year 3, $160,000,000 in year 4, $110,000,000 in year 5, and $80,000,000 in year 6. The baseline WACC or discount rate is 19.4%, but this may be adjusted depending on the risk of the location.

The following list of steps provides a structure that you should use in analyzing your new venture. Note: Carry all final calculations to two decimal places.

1. Determine the marginal tax rate (5 points)
2. Compute the Year 0 investment for the Project. (5 points)
3. Compute the annual operating cash flows for years 1-6 of the project. (20 points)
4. Compute the non-operating (terminal) cash flow at the end of year 6. (10 points)
5. Draw a timeline that summarizes all of the cash flows for your venture. (5 points)
6. Compute the IRR, payback, discounted payback, and NPV for the Project. (20 points)
7. Compute the standard deviation of the NPV of the project (10 points)
8. Prepare a report for the firm's CEO indicating which location if any should be accepted and why, including careful explanation of tradeoffs and concerns in non-financial factors. (40 points)
9. Assign dollar heuristics to pertinent non-financial factors and determine whether your recommendation in 10. is consistent with heuristics using the NPV criterion.

The third potential location is the Northern Mariana Islands. These pacific islands were strategically important to the US in World War II and remain US possessions to this day. Legally they represent an interesting middle ground between US and non-US operations. While part of the US, the islands were allowed to set their own immigration policy and had an extensive guest worker program, drawing workers from South East Asia and China. The islands are currently in economic disarray. Due to scandals involving the treatment of guest workers by the local government and employers most of the established garment manufacturers have completely pulled out of Saipan. Between 2002 and 2007 total payroll to manufacturing workers dropped from $185 million to $57 million as factories were shuttered. Citizens that grew accustomed to generous paychecks from positions in city government are now facing new fiscal realities.

There are many skilled workers that are unemployed and garment factories ready but unused. Consequently, the initial outlay to build here is $80,000,000 less than in Manaus or Waterloo. Due to the depressed nature of the economy in the islands bringing production there would have a large effect on the local economy and generate significant goodwill with the locals and remaining guest workers, especially if the firm were to pay the US minimum wage rather than the local minimum wage. Fixed costs there are $10,000,000 per year and variable costs are 35% of revenues. Due to the great distance and the use of older equipment, the chance quality never gets up to snuff is 10% rather than 5% in Manaus and salvage value of the machines and plant is $40,000,000 rather than $50,000,000. There is concern that the public will perceive a return of a garment company to Saipan as an invitation to return to abuse of guest workers although the company is confident in its ability to treat the guest workers fairly. Additionally the company has the option of funding geothermal production of electricity on Pagan, a volcanic island in the Marianas (http://smu.edu/smunews/geothermal/about-mariana-project.asp). This would reduce the variable cost from 35% to 32% at a cost of a $10,000,000 initial investment (the required investment is much greater but is offset by electricity revenue). The tax rate is 35% but due to rebates the effective rate is 17.5% on repatriated income. Management believes this location would product a project of typical risk and the usual WACC would be appropriate. Clothes made in this facility would be “Made in the USA” for labeling purposes. There is some regulatory uncertainty with respect to the local government, somewhat more so than in Manaus and significantly more than Waterloo. In Saipan the standard deviation of the revenue, fixed costs, and variable costs are 12%, $300,000, and 12% respectively.