Question

In: Accounting

AugRealElectronics is a midsized electronics manufacturer. The company president is Shelly Couts, who inherited the company....

AugRealElectronics is a midsized electronics manufacturer. The company president is Shelly Couts, who inherited the company. The company originally repaired radios and other household appliances when it was founded over 70 years ago. Over the years, the company has expanded, and it is now a reputable manufacturer of various specialty electronic items.  You, a recent business school graduate, have been hired by the company in its finance department.

One of the major revenue-producing items manufactured by AugReal is a smart phone. AugReal currently has one 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 tropical colors and is preprogrammed to play Jimmy Buffett music. However, as with any electronic item, technology changes rapidly, and the current smart phone has limited features in comparison with newer models. AugReal spent $750,000 to develop a prototype for a new smart phone that has all the features of the existing one but adds new features such as Pokémonluring and capturing. The company has spent a further $200,000 for a marketing study to determine the expected sales figures for the new smart phone.

AugReal can manufacture the new smart phone for $205 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 per year for the next five years, respectively, and no sales after the fifth year. The unit price of the new smart phone will be $485. The necessary equipment can be purchased for $34.5 million and will be depreciated on a seven-year MACRS schedule (see Table 6.3, p. 175).  It is believed the value of the equipment in five years will be $5.5 million.

Net working capital for the smart phones will be 20 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. AugReal has a 35 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

  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. Should AugReal produce the new smart phone?

REPORT STYLE

            Remember that your boss is a smart business person, but she is not a financial analyst like you.  You should lead her through the logic of your analysis to your conclusions. Be sure your report is accurate and professional:  your job (grade) is on the line!

The report should be single-spaced within paragraphs and double spaced between paragraphs.  Use headings for major sections.  Include page numbers.  Use Times 12-point font.  Pay attention to grammar and writing style.  Write your report in third person, active voice.  Include Excel Worksheet Objects as tables in the body of your report that show the numbers involved in your analysis.  Include a memo to your boss as the cover/transmittal page.  The memo should present your primary conclusions in a bullet list.  

Your submission should be a single Word document (maximum of 6 pages) uploaded into Canvas.  I will use the attached rubric in the grading process.  “Paste object” to put your cash flows from Excel into your Word file. This allows me to simply click on your tables to see the match behind your calculations.  DO NOT USE EXCEL LIKE A TYPEWRITER.  That is, let Excel do the calculations.  Don’t do the calculations with pen and paper or a calculator and then simply type in the numbers into an Excel sheet.  I want to see that you can use Excel for this assignment and that you understand the concept of pasting an object rather than a picture from Excel to Word.  Failure to use Excel in the manner described will result in a significant grade penalty (50%?) even if your numbers are technically correct.

Solutions

Expert Solution

Years Year 1 Year 2 Year 3 Year 4 Year 5
Sales units                                                                         64,000             106,000          87,000          78,000          54,000
Sales price per unit                                                                              485                    485               485               485               485
variable cost per unit                                                                              205                    205               205               205               205
Contribution per unit                                                                              280                    280               280               280               280
Sales price                                                                  31,040,000        51,410,000 42,195,000 37,830,000 26,190,000
20% of sales                                                                    6,208,000        10,282,000     8,439,000     7,566,000     5,238,000
Increase in working capital                                                                    6,208,000          4,074,000 (1,843,000)      (873,000) (2,328,000)
Initial cash outflow
Purchase of equipment                                                                  34,500,000
Useful life 7 years
Depreciation p.a. 4928571.429
Initial Investment                                                                  34,500,000
Years Year 1 Year 2 Year 3 Year 4 Year 5 Total
Contribution                                                                  17,920,000        29,680,000 24,360,000 21,840,000 15,120,000 108,920,000
Fixed costs                                                                    5,100,000          5,100,000     5,100,000     5,100,000     5,100,000     25,500,000
Increase in working capital                                                                    6,208,000          4,074,000 (1,843,000)      (873,000) (2,328,000)       5,238,000
Depreciation                                                                    4,928,571          4,928,571     4,928,571     4,928,571     4,928,571     24,642,857
PBT                                                                    1,683,429        15,577,429 16,174,429 12,684,429     7,419,429     53,539,143
Tax expenses (35%)                                                                       589,200          5,452,100     5,661,050     4,439,550     2,596,800     18,738,700
PAT                                                                    1,094,229        10,125,329 10,513,379     8,244,879     4,822,629     34,800,443
PVIF                                                                         0.8929               0.7972          0.7118          0.6355          0.5674            3.6048
Present value                                                                       976,990          8,071,850     7,483,215     5,239,769     2,736,489     24,508,313
Present value of Salvage     3,120,848       3,120,848
Present value of recovery of working capital     2,972,182       2,972,182
Face value Present value
PAT                                                                  34,800,443        24,508,313
Salvage value of equipment                                                                    5,500,000          3,120,848
Recovery of working capital                                                                    5,238,000          2,972,182
                                                                 45,538,443        30,601,343
Initial Investment                                                                  34,500,000
Amount from first year cash inflow                                                                    1,094,229
Amount from second year cash inflow                                                                  10,125,329
Amount from third year cash inflow                                                                  10,513,379
Amount from fourth year cash inflow                                                                    8,244,879
Amount from fifth year cash inflow                                                                    4,522,186
Pay back period is the time of return of initial investment which is 4.29 years as per the above table.
Profitability Index Present Value of all cash flows/Initial Investment
Present Value of all cash flows                                                                  30,601,343
Initial Investment                                                                  34,500,000
Profitability Index 0.8870
IRR The rate at which cash outflows is equal to cash inflows. The same is calculated by trial and error method and comes to around 8%.
NPV Present Value of all cash flows-Initial Investment
                                                                 (3,898,657)
Conclusion As there is no positive NPV, Augreal should not produce the product.

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