Case Study

:

App

Electronic

App Electronics is an electronics manufacturer located in Box Hill, Victoria. The company's Managing director is Shelly Chan, who inherited the company from her father. The company originally repaired radios and other household appliances when it was founded more than 30 years ago. Over the years, the company has expanded, and it is now a reputable manufacturer of various specialty electronic items. You have been hired by the company

in the finance department.

One of the major revenueproducing items manufactured by App Electronics is smart phone. App Electronics 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 colours and is preprogrammed to play Jimmy Barnes's music. However, as with any electronic item, technology changes rapidly, and the current smart phone has limited features in comparison with newer models. App Electronics has spent $700,000 developing a prototype for a new smart phone that has all the features of the existing one, but adds new features, such as WiFi Tethering. The company has spent a further $200,000 for a marketing study to determine the expected sales figures for the new smart phone.

App Electronics' production manager has produced estimates of the costs associated with the manufacture of the new smart phone. Variable costs are estimated at $200 per unit and fixed costs for the operation are expected to run at $5.1 million per year. The estimated sales volume is 64,000 units in Year 1; 100,000 units in Year 2; 87,000 units in Year 3; 80,000 units in Year 4; and 50,000 units in the final year -Year 5. The unit sale price of the new

smart phone will be $485. The necessary manufacturing equipment can be purchased at the beginning of the project for $34.5 million and will be for tax purposes over a sevenyear life (straightline to zero).It is believed the value of the manufacturing equipment in five years'time will be $5.5 million.

App Electronics has a 30% corporate tax rate and a 12% required return. Shelly has asked Robert to make report that answers the following questions:

1) What is the NPV of the project? Justification of each your cash flow and explanation of why you include it in the project evaluation is expected.

2) Shelly still has concerns about the new smartphone because she was not convinced that the sale projections estimated in question 1 were entirely accurate. Thus, she has asked Robert to perform sensitivity analysis to see how changes in the price of the new smartphone will affect the NPV of the project. She has suggested you to perform an analysis of the current smart phone market,and you have come up with an estimate of percentage change of 10% in the price of the App Electronics new smartphone. Please conduct this analysis for

a) the best case scenario and b) the worst case scenario.

3) Should App Electronics produce the new smart phone based on the NPV estimated in Question 1 and based on the sensitivity analysis in Question 2? Explain your decision