Protect IT is a company that makes protective cases for smart phones such as the iPhone. The company is considering a proposal to expand its product selection to include protective covers for tablet devices like the iPad and so far, the firm has spent $10,000 analysing the potential market for such a product. Management believes that many purchasers of cell phone cases will also buy tablets, and so the company has a built-in clientele for the new product line. If the company decides to undertake this project, it will begin selling new products next month when its new fiscal year begins on January 1, 2016. The company would therefore make the required investment before the end of the current fiscal year, that is, 31 December 2015.

The financial statements of Protect IT for the years 2014 and 2015 are given in Table 1 and Table 2. The management would like to understand its financial performance in 2015 relative to the industry. The ratios for the industry are given in Table 3.

Table 1 Balance Sheet as at December 31 (Figures in Thousands)

	2015	2014
Current Assets
Cash and Cash equivalents	440	213
Marketable Securities	35	28
Accounts receivables	1,619	1203
Inventories	615	530
Prepaid Expenses	170	176
Total Current Assets	2,879	2150
Fixed Assets
Gross Property, Plant and Equipment	9,920	9024
Less: Accumulated Depreciation	3,968	3335
Net Property, Plant and Equipment	5,952	5689
Intangible assets	758	471
Net fixed assets	6,710	6160
Total assets	9,589	8310
Current Liabilities
Accounts Payables	1,697	1304
Notes Payables	477	587
Accrued Expenses	440	379
Total Current Liabilities	2,614	2270
Longterm Liabilities
Deferred Taxes	907	793
Long term debt	1,760	1,474
Total long term Liabilities	2,667	2,267
Total Liabilities	5,281	4,537
Stockholder Equity
Preferred Stock	30	30
Common Stock ($1 par)	179	185
Paid in Capital in excess of par	442	386
Retained earnings	4,271	3,670
Less: Treasury Stock	614	498
Total Stockholder Equity	4,308	3,773
Total Liabilities and Stockholder Equity	9,589	8,310

Table 2 Income statement for the year ending 31 December (Figures in Thousands)

	2015	2014
Sales Revenue	12,843	9,110
Less: Cost of goods sold	8,519	5,633
Gross profit	4,324	3,477
Less: Operating and other expenses	1,544	1,521
Less Selling, General and Administrative Expenses	616	584
Less Depreciation	633	608
Operating Profit	1,531	764
Plus: Other income	140	82
EBIT	1,671	846
Less: Interest Expenses	123	112
Pretax Income	1,548	734
Less: Taxes
Current	367	158
Deferred	232	105
Total Taxes	599	263
Net Income	949	471
Less Preferred dividends	3	3
Earnings available for common stockholders	946	468
Less: Dividends	345	326
To Retained Earnings	601	142
Per share data
EPS	5.29	2.52
DPS	1.93	1.76
Price per share	76.25	71.50
Number of shares	178,719,400	185,433,100
Credit purchases (million$)	6,815	4,506

Table 3 Industry Ratios

Ratios	Industry average
Current ratio	1.23
Quick ratio	1.02
Inventory Turnover	16
Average Collection Period	42
Average payment period	100
Fixed Asset turnover	1.6
Total asset turnover	1.42
Debt ratio (Total liabilities/total assets)	38.65%
Assets/equity ratio (Equity Multiplier)	1.63
Longterm debt to stockholder equity	30.00%
Times Interest Earned Ratio	16.25
Gross profit margin	40.00%
Operating profit margin	12.00%
Net profit margin	8.50%

With respect to the new product introduction, the following information is obtained:

Up-front costs include $50,000 in computer equipment. This equipment will be depreciated over 5 years on a straight line basis and will have no salvage value at the end of 5 years.

The managers believe that the average selling price of the new tablet covers to be at $13.50 and they expect that the price will remain constant indefinitely.

Managers expect unit sales volume to start at 4,500. It is also estimated that the sales volume will increase by 10% a year from year 2 to year 5. From year 6 onwards, the sales volume will increase at a constant rate of 4% every year.

The cost of goods sold will be 72% of sales revenue with selling, general, and administrative expenses at 10% of sales.

No additional fixed asset investment will be necessary to support the increased sales.

At the start of the new project, Protect IT needs to provide $ 6,000 worth of working capital. Subsequently, as sales grow, Protect IT will make additional investments in inventory and receivables. Each year, accounts receivables will be equivalent to one-month sales, and inventory balances will be about 12.5% of sales.

Protect ITs suppliers will provide trade credit on terms such that the accounts payable

balance will equal about 10% of cost of goods sold each year.

By the end of year 5, the sales of the tablet covers will reach a steady state and cash flows

will grow at 4% a year indefinitely from year 6 onwards.

The beta of the company is estimated as 0.8.

The risk-free rate is 3% and the market risk premium is 6%.

Tax rate will be 20% for the project income.

The company has a target debt ratio of 40%. It can raise debt at 8%.

Question 1

Compute the following ratios for 2015.

Ratios	2015	Industry Average
Current ratio		1.23
Quick ratio		1.02
Inventory Turnover		16
Average Collection Period		42
Average payment period		100
Fixed Asset turnover		1.6
Total asset turnover		1.42
Debt ratio (Total liabilities/total assets)		38.65%
Assets/equity ratio (Equity Multiplier)		1.63
Longterm debt to stockholder equity		30.00%
Times Interest Earned Ratio		16.25
Gross profit margin		40.00%
Net profit margin		8.50%

(15 marks)

Question 2

Analyse the difference in the ROE of Protect IT and the ROE of the Industry in 2015 through the relevant ratios.

(20 marks)

Question 3

Calculate the weighted average cost of capital for the project.

(15 marks)

Question 4

Calculate the initial investment on December 31, 2015.

(10 marks)

Question 5

Calculate the cash flows for the years 2016 to 2020.

(20 marks)

Question 6

Calculate the terminal cash flow at the end of year 2020.

(10 marks)

Question 7

Calculate the net present value of this project and recommend whether the project should be undertaken.

(10 marks)