Jenny Hewes, a newly appointed assistant to the financial manager of the Smart Devises division of Freedom Communication, was asked to make a capital budgeting report to introduce a new line of smartphones with flexible screens. The new plants and equipment constructed today is $30 million and has a five years life. The company used straight-line depreciation and the market value of the plant and equipment are estimated to be $15 million. The division planned to sell the plants and equipment when the project is ended. According to the previous projects, the companys working capital is usually 20% of its sales and could be fully recovered. There is another old production line which annual sales is 40 million. Freedom Communication is not the only innovator among smart phone manufacturer. The market has more new entrants and Freedom must adjust its strategy to survive in the competitive environment.

From Jennys report, the new line costs $46 million and promises a 37% internal rate of return. She has recommended to accept the project.

Jenny was confident with the report but when she presented to the manager, it was attacked from all sides. Jenny was surprised and she needed to revise the report in one day. Can you help Jenny to correct her work and give her some advices on how to improve a capital budgeting report? (Note the question is an open ending question, you may not have specific data in some analytical parts, give comments and examples)

Below is Jennys capital budgeting report:

++ Year 1 2 3 4 5 $15 Plant and equipment Increased working capital Preliminary engineering Excess capacity 0 $(30) (14) (2) 0 $(46) Total investment Total salvage value $15 Sales Cost of sales $60 26 $82 35 $140 60 $157 68 $120 52 34 5 80 4 Gross profit Interest expense Allocated expenses Selling and administrative expenses 68 3 47 4 0 13 89 3 0 0 0 10 22 25 19 Total operating expenses Operating income Depreciation 14 20 3 17 29 3 26 54 3 28 61 3 22 46 3 3 Income before tax Tax at 40% 17 7 26 11 51 20 58 23 43 17 $10 $10 $16 $16 $30 $30 $35 $35 $26 $26 Income after Tax Operating Cash Flows Net Present Value @15% Profit Index Internal Rate of Return $(46) $35 1.76 37% ++ Year 1 2 3 4 5 $15 Plant and equipment Increased working capital Preliminary engineering Excess capacity 0 $(30) (14) (2) 0 $(46) Total investment Total salvage value $15 Sales Cost of sales $60 26 $82 35 $140 60 $157 68 $120 52 34 5 80 4 Gross profit Interest expense Allocated expenses Selling and administrative expenses 68 3 47 4 0 13 89 3 0 0 0 10 22 25 19 Total operating expenses Operating income Depreciation 14 20 3 17 29 3 26 54 3 28 61 3 22 46 3 3 Income before tax Tax at 40% 17 7 26 11 51 20 58 23 43 17 $10 $10 $16 $16 $30 $30 $35 $35 $26 $26 Income after Tax Operating Cash Flows Net Present Value @15% Profit Index Internal Rate of Return $(46) $35 1.76 37%