Question

EMU ELECTRONICS

Emu electronics is an electronics manufacturer located in Box Hill, Victoria. The company’s managing director is Shelly Chan, who inherited the company from the father. The company originally repaired radios and other household appliances when it was founded more than 50 years ago. Over the years. The company has expanded, and it is now a reputable manufacturer of various specialty electronics items. Robert McCanless, a recent MBA graduate, has been hired by the company in the finance department.     

One of the major revenue-producing items manufactured by Emu electronics is a smart phone. Emu electronics currently has a smart phone model on the market and sales have been excellent. The smart phone is a unique item in that it comes in a variety of colours and is pre-programmed to play Jimmy Barne’s music. However, as with any electronic item, technology changes rapidly, and the current smart phone has limited features in comparison with newer models. Emu electronics has spent $1 200 000 developing a prototype for a new smart phone that has all the features of the existing one, but adds new features, such as Wifi tethering. The company has spent a further $250 000 for a marketing study to determine the expected sales figures for the new smart phones.

   Emu electronics production manager has produced estimates of the costs associated with manufacture of the new smart phone. Variable costs are estimated at $210 per unit and fixed costs for the operation are expected to run at $5.3 million per year. The estimated sales volume is 64 000 units in the year 1; 106 000 units in the year 2; 87 000 units in the year 3; 78 000 units in Year 4; and 54 000 units in the final year. The unit price of the smart phone will be $515. The necessary manufacturing equipment can be purchased for $38.5 million and will be depreciated for tax purposes over a seven-year life (straight-line to zero). It is believed the value of the manufacturing equipment in five years’ time will be $5.8 million.

    Net working capital for the smart phones will be 20% of sales and will have to be purchased at the end of the year. The cost of the raw materials is reflected in the variable unit cost. Changes in NWC will first occur at the end of Year 1 based on the first years’ sales. Emu electronics has a 30% corporate tax rate and a 12% required return.

    Shelly has asked Robert to prepare a report that answers the following questions.

Based on the given data, pls find below steps, workings, data and
answers:
1. What is the payback period of the project?
2. What is the profitability index of the project?
3. What is the IRR of the project?
4. What is the NPV of the project?
5. How sensitive is the NPV to changes in the price of the smart
phone?

6. How sensitive is the NPV to changes in the quantity
sold?

7. Should Emu electronics produce the new smart phone?

NOTE: Please show full working and explanation on the steps.

Answer 1

Calculation of change in working capital

Year	-	1	2	3	4	5
Unit Sales		64,000	106,000	87,000	78,000	54,000
Unit Price		515	515	515	515	515
Sales Value		32,960,000	54,590,000	44,805,000	40,170,000	27,810,000
Net Working Capital Required(20% of Sales)		6,592,000	10,918,000	8,961,000	8,034,000	5,562,000
Increase in net working capital		6,592,000	4,326,000	(1,957,000)	(927,000)	(2,472,000)

Year	-	1	2	3	4	5
Equipment Expense	(38,500,000)
Sales		32,960,000	54,590,000	44,805,000	40,170,000	27,810,000
Variable Cost (Unit Sales*210)		13,440,000	22,260,000	18,270,000	16,380,000	11,340,000
Fixed Cost		5,300,000	5,300,000	5,300,000	5,300,000	5,300,000
Depreciation		5,500,000.00	5,500,000.00	5,500,000.00	5,500,000.00	5,500,000.00
Earning Before Tax		8,720,000.00	21,530,000.00	15,735,000.00	12,990,000.00	5,670,000.00
Tax @ 30%		2,616,000.00	6,459,000.00	4,720,500.00	3,897,000.00	1,701,000.00
Earning After Tax		6,104,000.00	15,071,000.00	11,014,500.00	9,093,000.00	3,969,000.00
Add back depreciation		5,500,000.00	5,500,000.00	5,500,000.00	5,500,000.00	5,500,000.00
Increase in net working capital		6,592,000	4,326,000	(1,957,000)	(927,000)	(2,472,000)
Book Value of Equipment at end of 5 year						11,000,000.00
Salvage Value						5,800,000.00
Tax on loss of asset						1,560,000.00
Total salvage value						7,360,000.00
Total Cash Flows	(38,500,000.00)	5,012,000.00	16,245,000.00	18,471,500.00	15,520,000.00	19,301,000.00
PV Factor(1/(1+.12)^year)	1.00	0.89	0.80	0.71	0.64	0.57
Discounted Cash Flows	(38,500,000.00)	4,475,000.00	12,950,414.54	13,147,648.85	9,863,240.58	10,951,905.74
NPV	12,888,209.71

1.

Payback Period
	Cash Flows	Cumulative cash Flows
1.00	5,012,000.00	5,012,000.00
2.00	16,245,000.00	21,257,000.00
3.00	18,471,500.00	39,728,500.00
4.00	15,520,000.00	55,248,500.00
5.00	19,301,000.00	74,549,500.00
		`
	Payback Period =	2 years+(38500000-21257000)/(39728500-21257000)
	Payback Period =	2.93 years

2.

Profitability Index	PV of Cash Inflows/PV of Cash Outflows
	= 51388209.70/38500000
	1.33

3.

IRR of the project

22.87%

4.

NPV	12,888,209.71

5.

Sesitivity to the change in price
Lets price incresed by 1, the NPV will be
Year	-	1	2	3	4	5
Unit Sales		64,000	106,000	87,000	78,000	54,000
Unit Price		516	516	516	516	516
Sales Value		33,024,000	54,696,000	44,892,000	40,248,000	27,864,000
Net Working Capital Required(20% of Sales)		6,604,800	10,939,200	8,978,400	8,049,600	5,572,800
Increase in net working capital		6,604,800	4,334,400	(1,960,800)	(928,800)	(2,476,800)
Year	-	1	2	3	4	5
Equipment Expense	(38,500,000)
Sales		33,024,000	54,696,000	44,892,000	40,248,000	27,864,000
Variable Cost (Unit Sales*210)		13,440,000	22,260,000	18,270,000	16,380,000	11,340,000
Fixed Cost		5,300,000	5,300,000	5,300,000	5,300,000	5,300,000
Depreciation		5,500,000.00	5,500,000.00	5,500,000.00	5,500,000.00	5,500,000.00
Earning Before Tax		8,784,000.00	21,636,000.00	15,822,000.00	13,068,000.00	5,724,000.00
Tax @ 30%		2,635,200.00	6,490,800.00	4,746,600.00	3,920,400.00	1,717,200.00
Earning After Tax		6,148,800.00	15,145,200.00	11,075,400.00	9,147,600.00	4,006,800.00
Add back depreciation		5,500,000.00	5,500,000.00	5,500,000.00	5,500,000.00	5,500,000.00
Increase in net working capital		6,604,800	4,334,400	(1,960,800)	(928,800)	(2,476,800)
Book Value of Equipment at end of 5 year						11,000,000.00
Salvage Value						5,800,000.00
Tax on loss of asset						1,560,000.00
Total salvage value						7,360,000.00
Total Cash Flows	(38,500,000.00)	5,044,000.00	16,310,800.00	18,536,200.00	15,576,400.00	19,343,600.00
PV Factor(1/(1+.12)^year)	1.00	0.89	0.80	0.71	0.64	0.57
Discounted Cash Flows	(38,500,000.00)	4,503,571.43	13,002,869.90	13,193,701.03	9,899,083.80	10,976,078.13
NPV	13,075,304.28

Sensitivity of change in sale price by $1

187,094.57

6.

Sensitivity of change in quanitity
Year	-	1	2	3	4	5
Unit Sales		65,000	107,000	88,000	79,000	55,000
Unit Price		515	515	515	515	515
Sales Value		33,475,000	55,105,000	45,320,000	40,685,000	28,325,000
Net Working Capital Required(20% of Sales)		6,695,000	11,021,000	9,064,000	8,137,000	5,665,000
Increase in net working capital		6,695,000	4,326,000	(1,957,000)	(927,000)	(2,472,000)
Year	-	1	2	3	4	5
Equipment Expense	(38,500,000)
Sales		33,475,000	55,105,000	45,320,000	40,685,000	28,325,000
Variable Cost (Unit Sales*210)		13,650,000	22,470,000	18,480,000	16,590,000	11,550,000
Fixed Cost		5,300,000	5,300,000	5,300,000	5,300,000	5,300,000
Depreciation		5,500,000.00	5,500,000.00	5,500,000.00	5,500,000.00	5,500,000.00
Earning Before Tax		9,025,000.00	21,835,000.00	16,040,000.00	13,295,000.00	5,975,000.00
Tax @ 30%		2,707,500.00	6,550,500.00	4,812,000.00	3,988,500.00	1,792,500.00
Earning After Tax		6,317,500.00	15,284,500.00	11,228,000.00	9,306,500.00	4,182,500.00
Add back depreciation		5,500,000.00	5,500,000.00	5,500,000.00	5,500,000.00	5,500,000.00
Increase in net working capital		6,695,000	4,326,000	(1,957,000)	(927,000)	(2,472,000)
Book Value of Equipment at end of 5 year						11,000,000.00
Salvage Value						5,800,000.00
Tax on loss of asset						1,560,000.00
Total salvage value						7,360,000.00
Total Cash Flows	(38,500,000.00)	5,122,500.00	16,458,500.00	18,685,000.00	15,733,500.00	19,514,500.00
PV Factor(1/(1+.12)^year)	1.00	0.89	0.80	0.71	0.64	0.57
Discounted Cash Flows	(38,500,000.00)	4,573,660.71	13,120,615.43	13,299,613.93	9,998,923.69	11,073,051.38
NPV	13,565,865.14
Change in NPV from increse in quantity by 1000 units in each year	677,655.43

7. Yes, EMU Electronics should accept the accept the project as it has positive NPV.

Hope u find the answer useful. All the best.