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Homework_4_Solutions

Homework_4_Solutions - UNIVERSITY OF NORTH CAROLINA AT...

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U NIVERSITY OF N ORTH C AROLINA A T C HAPEL H ILL K ENAN -F LAGLER B USINESS S CHOOL B USI 408: C ORPORATE F INANCE S OLUTIONS TO A SSIGNMENT #4 P ROF . A RZU O ZOGUZ F ALL 2009 1. Bourbon French Parfums (BFP) is a family owned company, specializing in high quality fragrances. Founded by the French ‘parfumeur’, August Doussan, in 1843, and situated in the ‘Vieux Carre’ of New Orleans, Louisiana, it had long catered to the city’s leading families. Only in the 1980s, did BFP establish a U.S. wide distribution network based on French luxury stores. The company CEO, Mary Behlar, contemplates the commercialization of a new fragrance named ‘Voodoo Love’. Based on previous experience with a similar product, the marketing director believes that 3,000 fragrances per month can be shipped to all U.S. outlets over the next five years at a price of $45 per 1 ounce flacon. Preliminary product design and marketing studies have cost BFP already $50,000. The studies show that the launching of the new product will necessitate the acquisition of new equipment costing a total of $2,500,000 delivered and installed. The company would finance the purchase of this equipment by borrowing $1,500,000 at 9 percent, and by paying the remaining $1 million in cash. The new equipment, if properly maintained, should allow BFP to produce at least 3,000 one-ounce flacons per month over the next five years. It is assumed that after 5 years of production, the equipment has a zero market value, and needs to be scrapped. The house perfumer estimates that the scent ingredients and other raw materials cost $10 per fragrance. Smooth production requires raw material inventory of approximately one month. Production can be carried out in a facility owned by BFP, and currently rented at $5000 per month to another company. Furthermore, the new production increases direct labor costs by $12,000 per month, energy costs $3,000 per month, and general overhead expenses by $10,000 a year. Finally, the accountant estimates that the pro-rata share of general and administrative expenses imputable to this project is $75,000 a year. These preliminary numbers have now reached the desk of the financial manager whom Ms. Behlar has asked to perform an economic and financial evaluation of the ‘Voodoo Love’ project. BFP’s accounts receivable are collected, on average, after 90 days, and its accounts payable (raw materials only) are settled, on average, also after 90 days. BFP’s weighted average cost of capital was estimated by its financial manager to be 12 percent. Given that
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