7. Reese’s Peanut Butter Cups Inc. has a series of 8
P i . Percent (coupon rate) bonds
contending a a a face value of $20 million. The bonds i ont priced at
. are due to mature in exactly 15 years. Th 7 i
trading at a price of $46.96. On 6 ifthe stock narker oc on I Rene
average, if the stock market goes up 1%, Reese’s
stock goes up 1.3%. If the stock market goes down 1%, Reese’s stock goes down
1 3%, There are 1.7 million shares of common stock outstanding. The risk-free rate of
interest is 3.0%. Over the past 100 years, the stock market has averaged 5.7% better
than the risk-free rate and you feel that this is likely to continue in the future. Reese’s
marginal tax rate is 35%.
Reese’s is planning to introduce a coconut peanut butter cup which it will produce for
five years. The initial cost of equipment will be $15,000, which can be depreciated on
a straight-line basis over the life of the project. You will need $2,000 of working
capital immediately and that level of working capital will be maintained throughout
the life of the project (no increases or decreases). The working capital will be
recovered when the project ends. Based on the results of a recently concluded test
market, sales are expected to be $10,000 per year. Reese’s spent $2,000 conducting
the test market. Variable costs for this new flavor are expected to be equal to 20
percent of sales, just as they are for the traditional flavor. There are no fixed costs.
The new flavor is expected to cause a $1,000 drop in sales of the traditional flavor
during the first year only. All cash flows should be discounted at the same rate.
Determine the appropriate free cash flows to use for an NPV analysis and show the
net FCF for each year on the time line below. Next, determine the WACC that
Reese’s should use, and then calculate the NPV of this project.
WACC: NPV: