You are to evaluate a (hypothetical) proposed new project for O'Reilly Automotive that involves getting into the automotive care products business, such as cleaners, waxes and conditioners in a major way, by manufacturing your own private brand of these products and distributing them through your stores. The following are the key assumptions that have been made regarding the project. Explain what your approach would be to evaluating the project, what capital budgeting method you would use, and make calculations using "time value of money" analyses discussed in class to demonstrate your conclusions.
â?¢ Project start date September 2011
â?¢ Initial and total Investment: $500,000
â?¢ Annual Net Revenue after all expenses: $100,000 the first year increasing 10% each year for a total project life of 10 years (beginning in 2011)
â?¢ Project is terminated after ten years of revenue, with a salvage value of $200,000
â?¢ O'Reilly's corporate Hurdle rate of return is 18%
â?¢ The project has been determined to be of above average risk
â?¢ You may make any additional reasonable assumptions that you feel are necessary, as long as you explain them clearly in your answer
What is the project worth to O'Reilly? Should it be undertaken? Describe your methodology. Does the salvage value influence whether you would undertake the project of not? Do you agree with the risk assessment? How does this affect the financial analysis? What discount rate or minimum IRR would be acceptable? Should this project be undertaken?
Income Statement YE 2010
Profit before interest 2,620,992
Interest expense 0
Profit before tax 2,620,992
Federal Tax (33%) 864927.36
Net Profit 1,756,065
P/E Ratio 9
The expert evaluates projects using the net present value method.