Creative Electronics is a mid-size electronics manufacturer located in Plano,Texas.Hoss Wright inherited the company from his father and now serves as its president.The company was started 60+ years ago and originally repaired radios and other small appliances.Since its inception, the company has greatly expanded and now manufacturers various specialty electronic items.Abilene Torres, a recent graduate from Rice University's MBA program was hired into the company's finance department.

One of EC's major revenue producing products is its smartphone.EC is currently marketing one smartphone.EC's smartphone is unique in that its casing comes in a variety of patterns representing different cowboy boot animal skins.Best sellers include alligator, ostrich, snake and goat. The phone is also pre-programmed to play the music of Lyle Lovett, a famous and beloved artist in the southwest.

However, technology in the smartphone industry is changing rapidly and EC's current smartphone has limited features compared with newer models.EC spent $750,000 to develop a prototype for a new smartphone that has all the features of its existing smartphone but added new features such as 5G internet capability and under-screen sensors. The company has additionally spent $200,000 for a marketing study to determine the expected sales figures for its new smartphone.

EC can manufacture the new smartphone for variable costs of $205/unit.Fixed costs are estimated to run $5.1million per year. Estimated 5-year sales volume in units:

Year 1$64,000

Year 2106,000

Year 387,000

Year 478,000

Year 554,000

Price per smartphone = $485

Production equipment can be purchased for $34.5 million and depreciated on a seven-year MACRS schedule.

Useful life of equipment - 5 years

Market Value of equipment$5.5 million

Net working Capital (NWC) = 20% of sales ( will occur with yearly timing of cash flows - meaning there is no initial outlay for NWC $ and that changes in NWC will occur in Year 1 with the first year's sales. (i.e. end year1 NWC same as beginning NWC in year 2 = 20% of year 1 sales)

Tax Rate 35%

Required rate of return12%

You are to assume the role of Abilene Torres and present a report for Hoss Wright addressing the following questions:

1.What is the payback period of the project

2.What is the IRR of the project

3.What is the NPV of the project

4.How sensitive is the NPV to changes in the price of the new smartphone

5.How sensitive is the NPV to changes in quantity sold

6.Should LSV produce the new smartphone

ADDITIONAL INFORMATION

Year 0 = $34,500,000 cost of new production equipment; (marketing and R&D costs are considered to be sunk costs).

Sales each year = quantity sold * price

VC each year = quantity sold * VC

The pro forma income statement and cash flow for the 5 years are listed below

Sales

Year 1

Year 2

Year 3

Year 4

Year 5

Sales

$31,040,000

$51,410,000

$42,195,000

$37,830,000

$26,190,000

VC

13,120,000

21,730,000

17,835,000

15,990,000

11,070,000

Fixed costs

5,100,000

5,100,000

5,100,000

5,100,000

5,100,000

Depreciation

4,930,050

8,449,050

6,034,050

4,309,050

3,080,850

EBT

$7,889,950

$16,130,950

$13,225,950

$12,430,950

$6,939,150

Tax

2,761,483

5,645,833

4,629,083

4,350,833

2,428,703

NI

$5,128,468

$10,485,118

$8,596,868

$8,080,118

$4,510,448

+ Depreciation

4,930,050

8,449,050

6,034,050

4,309,050

3,080,850

OCF

$10,058,518

$18,934,168

14,630,918

12,389,168

$7,591,298

NWC

Beg

$0

$6,208,000

10,282,000

$8,439,000

$7,566,000

End

6,208,000

10,282,000

8,439,000

7,566,000

0

NWC CF

-$6,208,000

-$4,074,000

$1,843,000

$873,000

$7,566,000

Net CF inflows

$3,850,518

$14,860,168

16,473,918

13,262,168

15,157,298

BV of equipment = $34,500,000 - 4,930,050 - 8,449,050 - 6,034,050 - 4,309,050 - 3,080,850 =

BV of equipment =

Taxes on sale of equipment = (BV - MV) (tax rate) =

CF on sale of equipment = $5,500,000 + 768,933 = $6,268,933