Security Manufacturing, Inc. is a producer of surveillance systems. Its current line of surveillance systems are selling excellently. However, in order to cope with the foreseeable competition from other similar products, SM spent $6,400,000 to develop a new line of HD surveillance systems (new model development cost).

The comprehensive 1440p HD surveillance system model can be used very well for any small home or business. As a result of the advanced HD analog technology made up of a4-channel 4K ultra high definition MPX digital video recorder with two 1440p bullet and two 1440p dome weatherproof security cameras, the system can produce videos of remarkable level of clarity and details at the marvelous2560x1440 resolution for live viewing and recording. This new and professional-grade system can also provide users with sharp HD resolution and outstanding night visions of up to 250 feet. The HD MPX DVRcomes with a hard drive size of 5TB and can support a hard drive up to 12TB of video storage. Using the MediaConnect coaxial cables, the MPX system does not only feature HD recording but also facilitates remote viewing and motion notifications.

The company had also spent a further $1,300,000to study the marketability of this new line of HD surveillance systems(marketability studying cost).

SM is able to produce the HD surveillance systems at a variable cost of $90 each. The total fixed costs for the operation are expected to be $8,000,000 per year. SM expects to sell 4,000,000 units, 4,500,000units, 3,500,000 units, 2,000,000 units and 1,500,000 units of the new HD surveillance system model per year over the next five years respectively. The HD surveillance systems will be selling at a price of $160 each. To launch this new line of production, SM needs to invest $33,000,000in equipment which will be depreciated on a seven-year MACRS schedule. The value of the used equipment is expected to be worth $3,500,000 as at the end of the 5 year project life.

SM is planning to stop producing the existing surveillance system model entirely in two years. Should SM not introduce theHD surveillance system, sales per year of the existing surveillance system model will be 1,900,000 units and 1,300,000 units for the next two years respectively. The existing model can be produced at variable costs of $70 each and total fixed costs of $7,500,000 per year. The existing surveillance system modelis selling for $130 each. If SM produces the HD surveillance system model, sales of existing model will be eroded by 1,140,000 unitsfor next year and 1,105,000units for the year after next. In addition, to promote sales of the existing model alongside with the HD surveillance system model, SM has to reduce the price of the existing model to $80 each. Net working capital for the HD surveillance system project will be 25 percent of sales and will vary with the occurrence of the cash flows. As such, there will be no initial NWC required. The first change in NWC is expected to occur in year 1 according to the sales of the year. SMis currently in the tax bracket of 35 percent and it requires a 20percent returns on all of its projects.The firm alsorequires a payback of 4 years for all projects.

You have just been hired by SM as a financial consultant to advise them on this HD surveillance system project. You are expected to provide answers to the following questions to their management by their next meeting which is scheduled sometime next month.

What is/are the sunk cost(s) for this HD surveillance system project? Briefly explain. You have to tell what sunk cost is and the amount of the total sunk cost(s). In addition, you have to advise SMon how to handle such cost(s).

What are the cash flows of the project for each year?

What is the payback period of the project?

What is the PI (profitability index) of the project?

What is the IRR (internal rate of return) of the project?

What is the NPV (net present value) of the project?

Should the project be accepted based on Payback, PI, IRR and NPV? Briefly explain.

Please enter the dollar amounts (including cash ows) below in whole numbers. Estimation of sunk costs Provide below the amounts ofthe sunk costs you identied from the case description above. 1st sunk cost $ 6400000 0 being New Model development 0 cost (Use exactly the same wording as in the case background information.) 2nd sunk cost: $ 1300000 0 being Marketability Studying 0 cost [Use exactly the same wording as in the case background information.) Total sunk costs = $ 7700000 0 Net Sales Estimation: Use the formula stated belowto calculate the net sales. Year 1 Net Sales =Unit sales of new model for Year I x Price of new model - Reduction in unit sales of existing model for Year t x Current price of existing model [(Unit sales of existing model for Year t if new model project is not launched Reduction in unit sales of existing model if new model project is launched) x {Current price of existing model Reduced price of existing model)] Net Sales Estimation: Use the formula stated below to calculate the net sales. Year t Net Sales =Unit sales of new model for Year t x Price of new model - Reduction in unit sales of existing model for Year t x Current price of existing model - [(Unit sales of existing model for Year t if new model project is not launched - Reduction in unit sales of existing model if new model project is launched) x (Current price of existing model - Reduced price of existing model)] Year 1 Net Sales = 4000000 * $ 160 - 1140000 * $ 130 ( 1900000 0 - 1140000 0) * ($ 130 0- $ 80 0) = $ 453800000 Year 2 Net Sales = 4500000 0 * $ 160 - 1105000 * $ 130 - ( 1300000 - 1105000 0) x ($ 130 0 - $ 80 0) = $ 566600000 Year 3 Net Sales = $ 560000000 O Year 4 Net Sales = $ 320000000 Year 5 Net Sales = $ 240000000Variable Cost Estimation: Use the formula stated below to calculate the variable costs. Year t Variable costs = Unit sales of new model for Year t x Variable cost per unit of new model - Reduction in unit sales of existing model for Year t x Variable cost per unit of existing model Year 1 Variable costs = 4000000 * $ 90 - 1140000 * $ 70 =$ 280200000 Year 2 Variable costs = 4500000 0 * $ 90 O - 1105000 0 * $ 70 =$ 327650000 O Year 3 Variable costs =$ 315000000 Year 4 Variable costs =$ 180000000 Year 5 Variable costs =$ 135000000 Depreciation Estimation: Use the formula stated below to calculate the depreciation expenses. Depreciation of Yeart = Cost of equipment x MACRS percentage for Year t [For all MACRS percentages in this part, enter as a decimal number with 4 decimal places.] Depreciation of Year 1 = $ 33000000 * 1429 0 =$ 4715700 Depreciation of Year 2 = $ 33000000 x .2449 =$ 8081700 Depreciation of Year 3 = $ 33000000 X .1749 =$ 5771700 Depreciation of Year 4 = $ 33000000 X 1.1249 =$ 4121700 Depreciation of Year 5 = $ 33000000 x .0893 =$ 2946900 ONet Working Capital Estimation: Use the formula stated below to calculate the net working capital requirements. NWC for Year t = NWC Required Percentage x Net sales of Year t [For the NWC required percentage in this part, enter as a decimal number with 2 decimal places.] NWC for Year 1 = .25 x $ 640000000 160000000 NWC for Year 2 = .25 x $ 720000000 180000000 NWC for Year 3 = .25 x $ 560000000 = 140000000 NWC for Year 4 = .25 x $ 320000000 =$ 80000000 NWC for Year 5 = $ 60000000CASH FLOW ESTIMATION: Complete the following table below. Year 1 Year 2 Year 3 Year 4 Year 5 Sales LA to VC Fixed costs Dep LA EBT Taxes (35%) NI + Dep OCF $ NWC Beg tA End NWC CF NCF $ toEstimation of total Year 5 cash ow: Provide your responses to the following. At the end of the project's 5-year life. Accumulated depreciation of equipment = $ |:| Book value of equipment = $ Market value of equipment = $ Tax associated with sale of equipment = $ |:| [Enter as a positive number iftax liability or as a negative number if tax credit] CF on sale of equipment = $ |:| Total Year 5 cash flow = $ |:| Hint: Net CF (Net cash ow) = OCF (Operating cash ow) + NWC CF {Net working capital cash ow) Year 1 through Year 4 cash flow = Net CF ofthe individual years. Year 5 cash flow = Net CF of Year 5 + CF on sales of equipment Evaluation of Project: Fill out the following tables. Year Cash flow O $ LA 2 3 LA 4 LA 5 LA (Do not round your calculations. Round your answers below to the number of decimal places specified.) Evaluation Method Payback years (2 decimal places) PI (Profitability Index) (2 decimal places) IRR (Internal Rate of Return) % (2 decimal places) NPV (Net Present Value) (whole number with no decimal place) (Enter "999" for Payback if the project will not payback. The "999" you provided does not mean that the project takes 999 years to payback. It is just that you tell the system that the project will not payback.)