GOODWEEK TIRES, INC.
After extensive research and development, Goodweek Tires, Inc., has recently developed a new
tire, the SuperTread, and must decide whether to make the investment necessary to produce and
market it. The tire would be ideal for drivers doing a large amount of wet weather and off-road
driving in addition to normal freeway usage. The research and development costs so far have
totaled about $10 million. The SuperTread would be put on the market beginning this year, and
Goodweek expects it to stay on the market for a total of four years. Test marketing costing $5
million has shown that there is a significant market for a SuperTread-type tire.
As a financial analyst at Goodweek Tires, you have been asked by your CFO, Adam Smith, to
evaluate the SuperTread project and provide a recommendation on whether to go ahead with the
investment. Except for the initial investment that will occur immediately, assume all cash flows
will occur at year-end.
Goodweek must initially invest $185 million in production equipment to make the SuperTread.
This equipment can be sold for $75 million at the end of four years. Goodweek intends to sell the
SuperTread to two distinct markets:
1. The original equipment manufacturer (OEM) market: The OEM market consists primarily
of the large automobile companies (like General Motors) that buy tires for new cars. In the
OEM market, the SuperTread is expected to sell for $43 per tire. The variable cost to
produce each tire is $31.
2. The replacement market: The replacement market consists of all tires purchased after the
automobile has left the factory. This market allows higher margins; Goodweek expects to
sell the SuperTread for $64 per tire there. Variable costs are the same as in the OEM market.
Goodweek Tires intends to raise prices at 1 percent above the inflation rate; variable costs also will
increase at 1 percent above the inflation rate. In addition, the SuperTread project will incur $53
million in marketing and general administration costs the first year. This cost is expected to
increase at the inflation rate in the subsequent years.
Goodweek’s corporate tax rate is 23 percent. Annual inflation is expected to remain constant at
3.25 percent. The company uses a 13.4 percent discount rate to evaluate new product decisions.
Automotive industry analysts expect automobile manufacturers to produce 8.5 million new cars
this year and for production to grow at 2.5 percent per year thereafter. Each new car needs four
tires (the spare tires are undersized and are in a different category). Goodweek Tires expects the
SuperTread to capture 11 percent of the OEM market.
Industry analysts estimate that the replacement tire market size will be 35 million tires this year
and that it will grow at 2 percent annually. Goodweek expects the SuperTread to capture an 8
percent market share.
The appropriate depreciation schedule for the equipment is the straight depreciation schedule. The
immediate initial working capital requirement is $10 million. Thereafter, the net working capital
requirements will be 15 percent of sales. What are the NPV, payback period, discounted payback
period, IRR, and PI on this project?
Using Excel software to provide your answer.
