CASE STUDY $2$

Spring $2024$ B$2$

Proposal Analysis

As the newly hired analyst for the corporate offices of Illuminated Electronics Corporation $($IEC$),$ you must prepare an analysis of a capital budgeting proposal.

Proposal $1$ PPD

IEC has just developed a new electronic device $($called the PPD$)$ and it believes it will have broad market appeal. The company has performed marketing and cost studies that revealed the following information:

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

B$)$ Sales in units over the next six years are projected to be as follows:

Year Sales in Units

$19,000$

$215,000$

$318,000$

$4622,000$

C$)$ Production and sales of the device 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.

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

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

F$)$ To gain rapid entry into the market, the company would have to advertise heavily. The advertising costs would be:

Year Amount of Yearly Advertising

$12$ $$180,000$

$3$ $$150,000$

$46$ $$120,000$

G$)$ The company$$s required rate of return in $14\%.$

Proposal $2$ NED

One of your colleagues has provided an analysis of a competing proposal and concluded the following:

NPV $=$ $$120,000$; IRR $=15\mathrm{.}5\%$; Payback Period $=3\mathrm{.}5$ years, Profitability Index $=1\mathrm{.}25$

Required:

$1)$ Compute the net cash inflow $($incremental contribution margin minus incremental fixed expenses$)$ anticipated from the sale of the PPDs for each year over the next six years.

$2)$ Using the data computed $(1)$ and other data provided in the problem, determine the net present value, internal rate of return, payback period, and profitability index of the proposed investment.

$3)$ Using the analysis performed in $(2),$ prepare $$best$$ and $$worst$$ case scenarios using the following assumptions:

a$)$ Best Case $$ Projected sales expectations increase by $10\%,$ required rate of return falls to $7\%.$

b$)$ Worst Case $$ Projected sales decreases by $10\%,$ required rate of return increases to $15\%.$

$4)$ Write a memo to the CFO of IEC providing your analysis and recommendation regarding the PPDs$.$ Be sure to compare your results to the competing proposal. Include a strong recommendation for or against the acceptance of the new PPDs into IEC$$s product line.