Question

XYZ Company is a reputable manufacturer of various especially electronic items. Jay Carter, a recent MBA graduate, has been hired by the company in its finance department.

On of the major revenue-producing items manufactured by the XYZ is smartphone. The company currently has one smartphone in the market and sells has been excellent. The smartphone is a unique item in that it comes in a variety of tropical colors and is preprogrammed to play Jimmy Buffett music. However, as with any electronic item, technology changes rapidly, and the current smartphone has limited features in comparison with newer models.

The company can manufacture the new smartphone for $300 each in variable costs. Fixed costs for the operation are estimated to run $5.1 million per year. The estimated sales volume is 64,000, 106,000, 87,000, 78,000, and 54,000 unit per year for the next five years, respectively.

The unit price of the new smartphone will be $485. The necessary equipment can be purchased for $31 million and will be depreciated on a seven-year MACRS schedule (Use Table A-1 below). It is believed the value of the equipment in five years will be $5.5 million.

Net working capital for the smartphones will be one time at $5,000,000 at the beginning of the project (time zero). XYZ has a 35% corporate tax rate and required return of 12%.

Jay was asked to prepare a report that answer the following questions:

1. What is the project NPV?
2. What is the Project IRR?
3. What is the payback period of the project?
4. What is profitability index of the project?
5. How sensitive is the NPV to change in the price of the new smartphone (assume that the price goes done to $370)?
6. How sensitive is the NPV to change in the quantity sold (assume that quantity reduce by 10%)?

Part 2- (25 Points)

1. What is a break-even (quantity)?
2. If the total interest payment be $150,000, what are the degrees of operating and financial leverage?

Assume that the company has the following capital structure:

Debt	$15,000,000
Preferred stock	$7,500,000
Common stock	$27,500,000

What will be the cost of capital if the company decide to raise the needed capital proportionally and with following costs? Please use the following information to calculate the weighted cost of capital:

1. Bond:

A 30-year bond with a face value of $1000 and coupon interest rate of 13% and floatation cost of $20 (Tax is 35%)

2. Preferred stock:

Face value of $35 that pays dividend $5 and floatation cost of $2

3. Common stock:

Market value of $54 with floatation cost of $3.5. Last dividend was $6. The dividend will expect to grow at 7%.

Uses the new cost of capital, calculate the NPV and IRR?

Answer 1

Tax	35%
WACC	12%
Year	Equipment Cost	Working Capital	Units Sold	Unit Price	Unit Cost	Fixed Cost	Depreciation
A	B	C	D	E	F	G	H
0	$        -31,000,000	$        -5,000,000
1			64,000	$                485	$               300	$ 5,100,000	14.29%
2			106,000	$                485	$               300	$ 5,100,000	24.49%
3			87,000	$                485	$               300	$ 5,100,000	17.49%
4			78,000	$                485	$               300	$ 5,100,000	12.49%
5			54,000	$                485	$               300	$ 5,100,000	8.93%
Year	Equipment Cost	Working Capital	Revenue	Variable Cost	Total Cost	Depreciation	Salvage Value	EBIT	EBIT *(1-T)	Net CF	Discount Factor	Discounted CF	NPV	IRR
			I=D*E	J=D*F	K=J+G	L=H*B	M	N=I-K-L+M	O=N*(1-T)	P=O+L	Q=1/(1+r)^A	R=P*Q	S=Sum R	T=IRR
0	$        -31,000,000	$        -5,000,000										$   -36,000,000	$ -5,532,172	-5.73%
1			$ 31,040,000	$ 19,200,000	$ 24,300,000	$ 4,429,900		$   2,310,100	$    1,501,565	$   5,931,465	0.892857143	$ 5,295,950.89
2			$ 51,410,000	$ 31,800,000	$ 36,900,000	$ 7,591,900		$   6,918,100	$    4,496,765	$ 12,088,665	0.797193878	$ 9,637,009.73
3			$ 42,195,000	$ 26,100,000	$ 31,200,000	$ 5,421,900		$   5,573,100	$    3,622,515	$   9,044,415	0.711780248	$ 6,437,635.95
4			$ 37,830,000	$ 23,400,000	$ 28,500,000	$ 3,871,900		$   5,458,100	$    3,547,765	$   7,419,665	0.635518078	$ 4,715,331.24
5			$ 26,190,000	$ 16,200,000	$ 21,300,000	$ 2,768,300	$      5,500,000	$   7,621,700	$    4,954,105	$   7,722,405	0.567426856	$ 4,381,899.99
Tax	35%
WACC	12%
Year	Equipment Cost	Working Capital	Units Sold	Unit Price	Unit Cost	Fixed Cost	Depreciation
A	B	C	D	E	F	G	H
0	$        -31,000,000	$        -5,000,000
1			64,000	$                485	$               300	$ 5,100,000	14.29%
2			106,000	$                485	$               300	$ 5,100,000	24.49%
3			87,000	$                485	$               300	$ 5,100,000	17.49%
4			78,000	$                485	$               300	$ 5,100,000	12.49%
5			54,000	$                485	$               300	$ 5,100,000	8.93%
Year	Equipment Cost	Working Capital	Revenue	Variable Cost	Total Cost	Depreciation	Salvage Value	EBIT	EBIT *(1-T)	Net CF	Discount Factor	Discounted CF	NPV	IRR
			I=D*E	J=D*F	K=J+G	L=H*B	M	N=I-K-L+M	O=N*(1-T)	P=O+L	Q=1/(1+r)^A	R=P*Q	S=Sum R	T=IRR
0	$        -31,000,000	$        -5,000,000										$   -36,000,000	$ -5,532,172	-5.73%
1			$ 31,040,000	$ 19,200,000	$ 24,300,000	$ 4,429,900		$   2,310,100	$    1,501,565	$   5,931,465	0.892857143	$ 5,295,950.89
2			$ 51,410,000	$ 31,800,000	$ 36,900,000	$ 7,591,900		$   6,918,100	$    4,496,765	$ 12,088,665	0.797193878	$ 9,637,009.73
3			$ 42,195,000	$ 26,100,000	$ 31,200,000	$ 5,421,900		$   5,573,100	$    3,622,515	$   9,044,415	0.711780248	$ 6,437,635.95
4			$ 37,830,000	$ 23,400,000	$ 28,500,000	$ 3,871,900		$   5,458,100	$    3,547,765	$   7,419,665	0.635518078	$ 4,715,331.24
5			$ 26,190,000	$ 16,200,000	$ 21,300,000	$ 2,768,300	$      5,500,000	$   7,621,700	$    4,954,105	$   7,722,405	0.567426856	$ 4,381,899.99

NPV = - $ 5,532, 172

IRR = -5.73%

Payback Period - No payback period as cumulative cash flow over 5 years is less than initial investment

Profitability Index = sum of PV of CF / initial investment = ($ 5,295,950.89 + $ 9,637,009.73 +$ 6,437,635.95+ $ 4,715,331.24+ $ 4,381,899.99) / 31,000,000 = 0.98