1. What are the annual cash flows for capital spending, cash flows for networking capital investments, and cash flows from operations?

2. What are the annual free cash flows from the investment?

3. What are the NPV, IRR, profitability index, and simple payback period of the investment? What is the conclusion of each rule (accept/reject)? KEC applies one-half of the investment life as the cutoff period to its all-new projects.

4. Assuming the following two scenarios, redo the analysis.

Optimistic case: 10 percent more unit sales and one percent lower required rate of return. Should KEC accept the project?

Pessimistic case: 10 percent less unit sales and one percent higher required rate of return. Should KEC accept the project?

5. Given all of the analysis results above, should KEC accept or reject the investment?

The auto vacuum cleaner division of Korea Electronics Co. (KEC), a manufacture of a variety of electric home appliances, sells several models of robot vacuum cleaners. Last year, the company spent KRW 10 billion to acquire the patent right for the auto wall cleaning technology that sweeps not only floors but also cleans wall surfaces. Using the technology, the company now plans to launch a new model called "Smart One. The R&D department of the company invested KRW 5 billion last year to incorporate the wall cleaning technology to a thin and long robot arm attached to the body of the machine. KEC also carried out a market test for the machine six months ago for the cost of KRW 1.5 billion. The results of the market test were quite optimistic. Based on the test marketing results and the company's own industry analysis, KEC expects that the marketability of the new product will last for the next six years, after which the KEC's robot arm wall cleaning technology will become obsolete and be replaced by newer and better technologies. The annual sales volume of Smart One for each of the next six years is projected as follows: [Table 1] Annual Unit Sales of Smart One Year 1 2 3 4 5 6 Sales (Unit) 70,000 100,000 120,000 120,000 100,000 60,000 KEC expects that the sales price of Smart One is KRW 1.3 million with the unit cost of KRW 1.1 million. KEC does not operate any manufacturing facilities and outsources all of its products to suppliers. In the case of Smart One, KEC plans to outsource the production of the model to Seoul Precision Machines Co. The afore-mentioned unit cost of KRW 1.1 million is all paid to Seoul Precision. Once the vacuum cleaners are manufactured by Seoul Precision, they will be shipped to one of the operation facilities of KEC in which the cleaners will be tested for any functional defects with a testing machine that is specially designed for the testing purpose for robot vacuum cleaners. The testing machine should be purchased at KRW 12 billion if the Smart One project is accepted. The machine will be depreciated over six years with straight line depreciation. While fully depreciated after six years, the machine can still be sold in the market for KRW 2 billion once the project is over according to industry experts. The selling and general expenses for the Smart One project are expected to be KRW 2 billion each year throughout the life of the project. The corporate tax rate is 25 percent. The required rate of return for the project is 10 percent. KEC considers to use an empty warehouse that is owned by the company as a place to store finished products. The warehouse is currently empty but had been rented out for KRW 0.8 billion per year. One concern that KEC's management has with the new project is that the new product might affect the sales of the existing lines of auto vacuum cleaners that the company is selling. The company's sales team forecasts that the introduction of Smart One will hurt the sales of the existing models: with a projected loss of 10 percent of the new (annual) sales of Smart One (with the same 10 percent of the cost of goods sold) from the existing lines of auto vacuum machines. Net working capital is one component that should always be considered as an important part of investment cash flows. The industry practice for estimating net working capital requirements for auto vacuum machine production is the accounts receivable of as much as 20 percent of the annual sales and the accounts payable of about 20 percent of the costs of goods sold each year. Since KEC does not manufacture the product, it does not need to carry inventory for parts and other raw materials. However, to meet changing demands, it needs to maintain inventory of finished products for 10 percent of expected annual sales. The auto vacuum cleaner division of Korea Electronics Co. (KEC), a manufacture of a variety of electric home appliances, sells several models of robot vacuum cleaners. Last year, the company spent KRW 10 billion to acquire the patent right for the auto wall cleaning technology that sweeps not only floors but also cleans wall surfaces. Using the technology, the company now plans to launch a new model called "Smart One. The R&D department of the company invested KRW 5 billion last year to incorporate the wall cleaning technology to a thin and long robot arm attached to the body of the machine. KEC also carried out a market test for the machine six months ago for the cost of KRW 1.5 billion. The results of the market test were quite optimistic. Based on the test marketing results and the company's own industry analysis, KEC expects that the marketability of the new product will last for the next six years, after which the KEC's robot arm wall cleaning technology will become obsolete and be replaced by newer and better technologies. The annual sales volume of Smart One for each of the next six years is projected as follows: [Table 1] Annual Unit Sales of Smart One Year 1 2 3 4 5 6 Sales (Unit) 70,000 100,000 120,000 120,000 100,000 60,000 KEC expects that the sales price of Smart One is KRW 1.3 million with the unit cost of KRW 1.1 million. KEC does not operate any manufacturing facilities and outsources all of its products to suppliers. In the case of Smart One, KEC plans to outsource the production of the model to Seoul Precision Machines Co. The afore-mentioned unit cost of KRW 1.1 million is all paid to Seoul Precision. Once the vacuum cleaners are manufactured by Seoul Precision, they will be shipped to one of the operation facilities of KEC in which the cleaners will be tested for any functional defects with a testing machine that is specially designed for the testing purpose for robot vacuum cleaners. The testing machine should be purchased at KRW 12 billion if the Smart One project is accepted. The machine will be depreciated over six years with straight line depreciation. While fully depreciated after six years, the machine can still be sold in the market for KRW 2 billion once the project is over according to industry experts. The selling and general expenses for the Smart One project are expected to be KRW 2 billion each year throughout the life of the project. The corporate tax rate is 25 percent. The required rate of return for the project is 10 percent. KEC considers to use an empty warehouse that is owned by the company as a place to store finished products. The warehouse is currently empty but had been rented out for KRW 0.8 billion per year. One concern that KEC's management has with the new project is that the new product might affect the sales of the existing lines of auto vacuum cleaners that the company is selling. The company's sales team forecasts that the introduction of Smart One will hurt the sales of the existing models: with a projected loss of 10 percent of the new (annual) sales of Smart One (with the same 10 percent of the cost of goods sold) from the existing lines of auto vacuum machines. Net working capital is one component that should always be considered as an important part of investment cash flows. The industry practice for estimating net working capital requirements for auto vacuum machine production is the accounts receivable of as much as 20 percent of the annual sales and the accounts payable of about 20 percent of the costs of goods sold each year. Since KEC does not manufacture the product, it does not need to carry inventory for parts and other raw materials. However, to meet changing demands, it needs to maintain inventory of finished products for 10 percent of expected annual sales