Question

In: Accounting

Jericho Manufacturing developed a new wireless phone charger which also uses the excess heat generated during...

Jericho Manufacturing developed a new wireless phone charger which also uses the excess heat generated during the process to keep your coffee warm at a predetermined temperature. The company is anxious to begin production of the new charger. To this end, marketing and cost studies have been made to determine probable costs and market potential. These studies have provided the following information:

New equipment would have to be acquired to produce the device. The equipment would cost $315,000 and have a 12-year useful life. After 12 years, it would have a salvage value of about $15,000.

Sales in units over the next 12 years are projected to be as follows:

Year

Sales in Units

1

6,000

2

12,000

3

15,000

4-12

18,000

Production and sales of the charger would require working capital of $60,000 to finance accounts receivable, inventories, and day-to-day cash needs. This working capital would be released at the end of the project’s life.

The devices would sell for $35 each; variable costs for production, administration, and sales would be $15 per unit.

Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $135,000 per year. The depreciation is based on cost less salvage value.

To gain rapid entry into the market, the company would have to advertise heavily. The advertising program would be:

Year

Annual Advertising Expenses

1-2

$180,000

3

$150,000

4-12

$120,000

The company’s board of directors has specified a required rate of return of 14% on all new products.

Requirements (Ignore income taxes)

You have been asked by your boss to evaluate the charger proposal from a capital budgeting perspective. You are to analyze the above data and prepare a memo to your boss recommending whether or not the company should accept the charger as a new product (5 points). Supplemental tables should be included in your memo as necessary to explain amounts included in the memo and support your recommendation.

As part of your evaluation, you should perform the following at a minimum.

Compute the net cash inflow (cash receipts less yearly cash operating expenses) anticipated from sale of the device for each year over the next 12 years. A table supporting this computation should be included. (10 points)

Using the data computed in (1) above and other data provided in the problem, determine each of the following for the proposed investment. Tables supporting each computation should be included as part of your memo, as necessary.

Net present value (10 points)

Internal rate of return (10 points)

Payback period (10 points)

Solutions

Expert Solution

in the memo the proposal is rejected as net present value is negative . the caculation given below

Ans

Following assumptions are taken for calculating the net cash inflow (cash receipts less yearly cash operating expenses)

  • Depreciation per year is $25,000 calculated as below

Depreciation per year = ( cost of equipment – salvage value ) /total useful year

=( $315,000-$15,000)/12

=$300,000/12
=$25,000

  • Depreciation is not a cash outflow item as cash is not actually paid but a entry made as per matching accounting concept

The Calculation of the net cash inflow (cash receipts less yearly cash operating expenses) anticipated from sale of the device for each year over the next 12 years.

Is given below

year

1

2

3

4

5

6

7

8

9

10

11

12

sales in unit

6000

12000

15000

18000

18000

18000

18000

18000

18000

18000

18000

18000

selling price per unit

35

35

35

35

35

35

35

35

35

35

35

35

Net sales in $

210000

420000

525000

630000

630000

630000

630000

630000

630000

630000

630000

630000

less -Variable cost @$15

90000

180000

225000

270000

270000

270000

270000

270000

270000

270000

270000

270000

Contribution

120000

240000

300000

360000

360000

360000

360000

360000

360000

360000

360000

360000

Less- fixed cost

135000

135000

135000

135000

135000

135000

135000

135000

135000

135000

135000

135000

less-advertising cost

180000

180000

150000

120000

120000

120000

120000

120000

120000

120000

120000

120000

net income

-195000

-75000

15000

105000

105000

105000

105000

105000

105000

105000

105000

105000

Add-depreciation

25000

25000

25000

25000

25000

25000

25000

25000

25000

25000

25000

25000

Cash inflow/(outflow)

-170000

-50000

40000

130000

130000

130000

130000

130000

130000

130000

130000

130000

Let us calculate the NPV . the following assumptions are made

The cost of capital or required return is 14% the present value factor will be 14%

The working capital required at year 0 will be $60,000 and will be recovered at year 12

The net present value is calculated as under

calculation of NPV

year

0

1

2

3

4

5

6

7

8

9

10

11

12

cost of new equipment

-315000

working capital required

-60000

Total cash ouflow

-375000

0

0

0

0

0

0

0

0

0

0

0

0

cash receipts inflow/outflow

-170000

-50000

40000

130000

130000

130000

130000

130000

130000

130000

130000

130000

salvage value

15000

working capital

60000

total cash inflow

0

-170000

-50000

40000

130000

130000

130000

130000

130000

130000

130000

130000

205000

net cash flow (inflow-outflow)

-375000

-170000

-50000

40000

130000

130000

130000

130000

130000

130000

130000

130000

205000

PV @14%

1

0.877193

0.769468

0.674972

0.59208

0.519369

0.455587

0.399637

0.350559

0.307508

0.269744

0.236617

0.207559

net cash inflow at present value factor

-375000

-149123

-38473

26999

76970

67518

59226

51953

45573

39976

35067

30760

42550

cumulative NPV

-375000

-524123

-562596

-535597

-458627

-391109

-331883

-279930

-234357

-194381

-159314

-128554

-86005

The net present value ($86,005) means the cash outflow is more than inflow at required rate of return of 14% hence the proposal is rejected

Calculation of IRR

internal Rate of Return is the interest rate that makes the Net Present Value zero.

As per IRR calculator the rate is 11.23% per annum

Calculation of payback period

The following points are to be noted

The investment in equipment is net of salvage value is $300,000

The working capital will be added in cash outflow for calculation in payback period which is $60,000

The total cashflow at year Zero is $360,000 and calculate at what period this amount is recovered

The cumulative cashflow is calculated as below

payback period

year

net cashflows

cumlative cash inflow

1

-170000

-170000

2

-50000

-220000

3

40000

-180000

4

130000

-50000

5

130000

80000

6

130000

210000

7

130000

340000

8

130000

470000

9

130000

600000

10

130000

730000

11

130000

860000

12

130000

990000

Payback period is = year7 +(20,000/130,000)

=7 +0.1538

Payback years is 7.1538 years


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