Intermedians Inc. manufactures and sells industrial adhesives to car manufacturers. They are considering an R&D project to develop a new line of adhesives with reduced volatile organic compounds (less pollution when used). R&D is expected to take four years. Product launch, assuming R&D is successful, would occur in year 5. ($s in 000s)
Year 1 2 3 4 5 6 7 8 9 10
Expected Cash Flow $2,350 $3,250 $6,700 $5,750 $26,000 $11,250 $18,450 $25,125 $28,100 $31,000
Intermedians would need to pay Rutgers $500 in Year 0 to license a technology to produce the new line of adhesives.
Part A
i. The company's CFO has determined that a 45% required rate of return be used to evaluate the project. What were the drivers in the CFO's decision?
ii. Should Intermedians consider funding this project?
Part B
The new mixing and testing equipment would be upgrades that use proven technology. Expected cash flows for years 1-4 with this new equipment are as shown below.
Year 1 2 3 4
Expected Cash Flow with new Equipment ($2,005 $2,850 $6,175 $4,850)
Expected cash flows for Years 5-10 are unchanged and Intermedians would still have to pay Rutgers for their technology ($975).
i. What required rate of return would you use to evaluate the decision to purchase and install the new equipment? (Choose one)
15%
25%
35%
40%
Explain your choice.
ii. Using the required rate of return chosen above, should Intermedians purchase and install this equipment?