Question

CHAPTER 9 CASE Jackson Erectors    Making Capital Investment Decisions

Jackson Erectors is a midsized electronics manufacturer located in Austin, Texas. The company president is Shelly Couts, who inherited the company. The company originally repaired radios and other household appliances when it was founded more than 70 years ago. Over the years, the company has expanded, and it is now an established manufacturer of various specialty electronic items. The company’s finance department has hired YOU, a recent MBA graduate to do an analysis of a proposed new product.

One of the major revenue-producing items manufactured by Jackson is a “controller” which are used in various types of automated equipment. Jackson currently has one model on the market and sales have been good. The technology in electronic devices is constantly changing. However, as with any electronic item, technology changes rapidly, and the current model has limited features in comparison with newer models. Jackson spent $400,000 to develop a prototype for a new controller that will be “state of the art”. The company has spent a further $100,000 for a marketing study to determine the expected sales figures for the new model.

Jackson can manufacture the new controller for $300 each in variable costs. Fixed costs for the operation are estimated to run $4.0 million per year. The estimated sales volume is 70,000, 90,000, 95,000, 85,000, and 75,000 per year for the next five years, respectively. The unit price of the new controller will be $550. The necessary equipment can be purchased for $40.0 million and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $2.5 million.

Net working capital for the controller will be 15 percent of sales and will occur with the timing of the cash flows for the year (i.e., there is no initial outlay for NWC). Changes in NWC will thus first occur in Year 1 with the first year's sales. Jackson has a 30 percent corporate tax rate and a required return of 12 percent. Shelly has asked you to prepare a report that answers the following questions:

QUESTIONS

Prepare a detailed pro forma income statement including calculation of Operating Cash Flows

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 new Controller? Assume a 5% price reduction
6. How sensitive is the NPV to changes in the quantity sold? Assume a 700 per year unit reduction in quantity sold
7. Should Jackson produce the new Controller?
8. Suppose Jackson looses sales on other models because of the introduction of the new model. How would this affect your analysis?

Answer 1

	JACKSON ERECTORS:	0	1	2	3	4	5
	Sales in units		70000	90000	95000	85000	75000
	Sales revenue (at $550/unit)		38500000	49500000	52250000	46750000	41250000
	Variable cost (at $300/unit)		21000000	27000000	28500000	25500000	22500000
	Fixed costs (other than depreciation)		4000000	4000000	4000000	4000000	4000000
	Depreciation (7 Year MACRS) %		14.29	24.49	17.49	12.49	8.93
	Depreciation expense		5716000	9796000	6996000	4996000	3572000	31076000	8924000
	EBIT		7784000	8704000	12754000	12254000	11178000
	Tax at 30%		2335200	2611200	3826200	3676200	3353400
	NOPAT		5448800	6092800	8927800	8577800	7824600
	Add: Depreciation		5716000	9796000	6996000	4996000	3572000
	OCF		11164800	15888800	15923800	13573800	11396600
	Capital expenditure	40000000
	Change in NWC		5775000	1650000	412500	-825000	-825000	6187500
	Release of NWC						6187500
	After tax salvage value = [2500000+(8924000-2500000)*30%]						4427200
	After tax annual cash flows	-40000000	5389800	14238800	15511300	14398800	22836300
1)	PAYBACK PERIOD:
	Cumulative after tax cash flows	-40000000	-34610200	-20371400	-4860100	9538700	32375000
	Payback period = 3+4860100/14398800 =	3.34	Years
2)	PVIF at 12% [PVIF = 1/1.12^n]	1	0.89286	0.79719	0.71178	0.63552	0.56743
	PV at 12%		4812321	11351084	11040637	9150698	12957930	49312670
	PI = PV of cash inflows/Initial investment = 49312670/40000000 =	1.23
3)	IRR:
	PVIF at 20%	1	0.83333	0.69444	0.57870	0.48225	0.40188
	PV at 20%	-40000000	4491500	9888056	8976447	6943866	9177397	-522735
	PVIF at 19%	1	0.84034	0.70616	0.59342	0.49867	0.41905
	PV at 19%	-40000000	4529244	10054940	9204651	7180232	9569537	538603
	IRR = 19%+1%*538603/(538603+522735) =	19.51%
4)	NPV:
	= PV of cash inflows-Initial investment = 49312670-40000000 =	$           93,12,670

7)   

The project should be accepted for the following reasons:

*NPV is positive

*PI is greater than 1

*IRR is greater than WACC