MEE is a midsized electronics manufacturer located in the Western European Region. The firm is owned by a US-based Electronics Major which has plants in the UK, Germany, and Malaysia. The European unit is a reputable manufacturer of various electronic items catering to the domestic and export markets. One of the major revenue-producing items manufactured by MEE is an Electronic Smart Tablet (EST). MEE has one EST model on the market, and sales have been excellent.

However, as with any electronic item, technology changes rapidly, and the current EST has limited features in comparison with newer models. MEE Spent $420,000 to develop a prototype for a new EST that has all the features of the existing model but adds new features such as fingerprint recognition. The company has spent a further $300,000 for a marketing study to determine the expected sales figures for the new

EST. MEE can manufacture the new EST for $190 each in variable costs. Fixed costs for the operation are estimated to run $4.8 million per year. The estimated sales volume is 75,000, 94,000, 126,000, 113,000, 90,000, and 72,000 per each year for the next six years, respectively. The unit price of the new EST will be $410. The necessary equipment can be purchased for $27 million and will be depreciated on a straight-line basis. It is believed the value of the equipment in 6 years will be $3 million.

The production of the existing model is expected to be terminated in three years. If MEE does not introduce the new EST, sales of the existing EST will be 70,000, 64,000 units and 55,000 units for the next three years, respectively. The price of the existing EST is $310 per unit, with variable costs of $135 each and fixed costs of $1,700,000 per year including a depreciation of $0.7 million.

If MEE does introduce the new EST, sales of the existing EST will fall by 17,000 units per year, and the price of the existing units will have to be lowered to $270 each. Net working capital for the ESTs will be 20 percent of sales and will occur with the timing of the cash flows for the year; for example, there is no initial outlay for Net Working Capital, but changes in NWC will first occur in year 1 with the first years sales. MEE has a 32 percent corporate tax rate. The company would like to use a WACC of 12 percent for this proposed project. The finance department of the company is studying the viability of introducing the new EST and its impact on the existing model.

Required:

a. Estimate the annual cash flows from the existing model if the new EST is not introduced

b. Estimate the annual cash flows from the existing model if the new EST is introduced.

c. Determine the incremental annual cash flows of the new EST.

d. Evaluate the viability of the project using all the relevant capital budgeting techniques.

e. Study the sensitivity of the project for changes to various key project inputs. Use the What-if Analysis tools to build the case.