In: Accounting
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
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.
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. |