Based on Chapter 10: Making Capital Investment Decisions:

Miguel Electronics Corporation is a midsized electronics manufacturer located in Key West, Florida. The company president is Mr. Nikola, who inherited the company. When it was founded over 70 years ago, the company originally repaired radios and other household appliances. Over the years, the company expanded into manufacturing and is now a reputable manufacturer of various electronic items. Mr. Justin, a recent MBA graduate, has been hired by the companys finance department.

One of the major revenue-producing items manufactured by Miguel Electronics is a smartphone. Miguel Electronics currently has one smartphone model on the market, and sales have been excellent. The smartphone 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 smartphone has limited features in comparison with newer models. Miguel Electronics spent $750,000 to develop a prototype for a new smartphone that has all the features of the existing smartphone but adds new features such as WiFi tethering. The company has spent a further $200,000 on a marketing study to determine the expected sales figures for the new smartphone.

Miguel Electronics can manufacture the new smartphones for $220 each in variable costs. Fixed costs for the operation are estimated to run at $6.4 million per year. The estimated sales volume is 155,000, 165,000, 125,000, 95,000, and 75,000 per year for the next five years, respectively. The unit price of the new smartphone will be $535. The necessary equipment can be purchased for $43.5 million and will be depreciated on a seven-year MACRS schedule. It is believed that the salvage value of the equipment in five years will be $6.5 million.

As previously stated, Miguel Electronics currently manufactures a smartphone. Production of the existing model is expected to be terminated in two years. If Miguel Electronics does not introduce the new smartphone, sales will be 95,000 units and 65,000 units for the next two years, respectively. The price of the existing smartphone is $385 per unit, with variable costs of $145 each and fixed costs of $4.3 million per year. If Miguel Electronics does introduce the new smartphone, sales of the existing smartphone will Page 1 of 2 fall by 30,000 units per year, and the price of the existing units will have to be lowered to $215 each. Net working capital (NWC) for the smartphones will be 20 percent of sales and will occur with the timing of the cash flows for the year; for example, there is no initial outlay for NWC, but changes in NWC will first occur in Year 1 with the first years sales. Miguel Electronics has a 21% corporate tax rate and a required return of 12 percent.

Mr. Nikola has asked Mr. Justin to prepare a report that answers the following questions and make an accept/reject decision based on the following capital budgeting techniques.

a. What is the payback period (PP) of the project?

b. What is the profitability index (PI) of the project?

c. What is the IRR of the project?

d. What is the NPV of the project?