Goodweek Tire, Inc., has recently developed a new tire, the SuperTread, and must decide whether to make the investment. The research and development costs so far total $10 million. Market research (costing $5 million) shows that there is significant demand for a SuperTread type tire.
The SuperTread will be produced and sold for the next two years. Goodweek Tire must initially invest $120 million in production equipment. This equipment can be sold for $51,428,571 at the end of two years. The equipment is classified as 15-year property for depreciation purposes.
The SuperTread is expected to sell for $45 per tire. The variable cost for each SuperTread is $15. Analysts expect automobile manufacturers to build five million new cars this year and for production to grow 2.5% in the following year. Each new car needs four tires. Goodweek Tire expects the SuperTread to capture 10 percent of the market. Assume that revenues and expenses occur at the end of each of the two years of production.
Working capital is equal to 15% of sales. Investments in working capital are made at the beginning of each year. At the end of the terminal year, the working capital is liquidated. Assume a tax rate of 40%. What are the operating cash flows at the end of Year 1?
MACRS Depreciation Rates
| Year | 10-Year | 15-Year |
| 1 | 10.00% | 5.00% |
| 2 | 18.00% | 9.50% |
| 3 | 14.40% | 8.55% |
◦ 11.6625M
◦ 25.4625M
◦ 30.2625M
◦ 38.0625M
◦ 38.4000M
Elephant footprints (tire tracks for scale)
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