Financial accounting

AK COMPUTERS

(Capital Budgeting/Cash Flows)

JAK Computers (JAKC) is a small computer hardware company that assembles

quality components into clone systems at extremely low prices. The company began in

the back room of a local computer supply company that offered disk drives, modems,

cables, and memory upgrades to individuals with sufficient computer knowledge to

expand their own systems with minimal technical assistance. In the process of advising

customers on what components could be added to upgrade their current systems, the two

founding partners realized that they were essentially designing personalized systems and

that there was a significant market for offering their complete systems to first-time

computer buyers as well as individuals interested in moving up to more powerful

systems. The recent progression of Pentium I, Pentium II, Pentium III, and now Pentium

IV chips had left most consumers confused and unsure of what they needed to stay up on

the newest technology without getting caught in a continuous process of upgrading

complete systems every year. JAKC offered a system to meet the customer's current

needs, and the option to upgrade to a more powerful CPU at a later date without replacing

their entire system. In addition, these custom systems could be sold for about one-half

the price of comparable systems from Hewlett Packard, Dell, Compaq, Gateway, and

other major suppliers.

Sales revenues have been increasing rapidly over the last couple of years as

consumers realized that these custom systems were put together with the same high

quality components that were found in those provided by the major suppliers. In fact, the

two founding partners were now selling these systems as fast as they could be assembled

and revenues could not increase any more without a major expansion of operations. This

would include additional facilities, component inventories, and the hiring of both

assembly and sales personnel. Since both partners were educated in computer science

and knew very little about the analysis of business investment, they decided to hire a

student consulting group from a class at the Florida State University to provide them with

a table of cash flows and an accept/reject recommendation.

Since the two partners would retain their current operations as a separate entity,

all of the data that they have provided should be viewed as incremental values. The

following additional information is provided for your analysis.

(1) The venture should be based on a five-year planning horizon since that would be the

length of the facility lease as well as the expected useful life of the required electronics

test equipment and other specialized tools. Additionally, both partners agreed that the

current market was based on the 3+ Ghz Pentium IV technology and that a horizon

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beyond five years would be very risky given the extreme uncertainty of forthcoming

INTEL research and product introductions.

(2) The leased facilities consist of a 20,000 square foot building requiring a $30,000

annual lease.

(3) The specialized equipment and tools as well as the installation modifications will cost

$100,000 and are classified as three-year MACRS property by IRS. It is projected that

these items can be sold for about $18,000 at the end of the five years.

(4) An inventory of required component parts is projected at $60,000 in the first year

building up to a maximum of $90,000 by the end of the second year. Accounts

Receivable are projected at $30,000 in the first year and should reach a maximum of

$50,000 by the end of the second year. Accounts Payable and Accruals are projected at

$25,000 and $20,000 respectively and should reach these levels in the first year. 100% of

working capital will be recovered at the end of this project.

(5) Labor and Salary expense is projected at $130,000 per year.

(6) Utilities expense is projected at about $6,000 per year.

(7) JAKC expects to assemble and sell 600 systems per year at an average price of

$2,000 per system.

(8) The cost of the component parts that will be used in the systems will average about

70 percent of the system price.

(9) The marginal tax rate is 35 percent.

(10) The cost of capital is 11 percent.

In developing your final cash flow table, you have been asked to be extremely

clear in your explanations since you are presenting your analysis and conclusions to

individuals who are not schooled in this type of analysis.