SmarT Phone, Inc. is a small electronics firm that has had success in developing smart phone handsets for the prepaid smartphone market. The company is in the pre-production phase of a new smartphone that improves upon the features of current models by adding new features, colors and sizes. The company has already spent $750,000 developing prototypes and another $200,000 for marketing studies to determine the expected sales figures for new smartphones.

SmarT Phone, Inc. can manufacture the new smart phone for $205 each in variable costs. Fixed costs for the operation are estimated to run $5.1 million per year. The estimated sales volume for the next 5 years is as follows:

Year

Units

1

64,000

2

106,000

3

87,000

4

78,000

5

54,000

The unit price of the new smart phone will be $485. The necessary equipment to manufacture the new smartphone can be purchased for $34.5 million and will be depreciated on a seven year MACRS schedule. The company believes that the value of the equipment in five years will be $5.5 million. The MACRS tax schedule for 7 year property is presented below:

Year

Depreciation

1

14.29%

2

24.49%

3

17.49%

4

12.49%

5

8.93%

6

8.92%

7

8.93%

8

4.46%

Net working capital for this new smartphone will be 20 percent of sales and will occur with the timing of cash flows for the year; i.e., there is no initial outlay for NWC. Changes in NWC will thus first occur in Year 1 with the first year's sales. The company has a 35 percent corporate rate and a required rate of return of 12 percent.

INSTRUCTIONS: The CEO and COO have asked you to provide an analysis of the feasability of this project. Please complete the schedule below and answer the questions provided. Finally, please provide your recommendation as to whether this project should be accepted or rejected. IN OTHER WORDS, FILL IN ALL OF THE BLANK AREAS BELOW.

Schedule of Projected Cash Flows for the Smart Phone Project

YEAR

0

1

2

3

4

5

MACRS Depreciation

$ 34,500,000

Equipment Cost

$ (34,500,000)

Year

MACRS

Depreciation

Net Book Value

Sales in units

64,000

106,000

87,000

78,000

54,000

1

14.29%

$ 4,930,050

$ 29,569,950

Sales Price

$485

$485

$485

$485

$485

2

24.49%

$ 8,449,050

$ 21,120,900

Sales Revenue

$ 31,040,000

$ 51,410,000

$ 42,195,000

$ 37,830,000

$ 26,190,000

3

17.49%

$ 6,034,050

$ 15,086,850

Variable Costs @ $205 per unit

13,120,000

21,730,000

17,835,000

15,990,000

11,070,000

4

12.49%

$ 4,309,050

$ 10,777,800

Fixed Costs

5,100,000

5,100,000

5,100,000

5,100,000

5,100,000

5

8.93%

$ 3,080,850

$ 7,696,950

Depreciation

$ 4,930,050

$ 8,449,050

$ 6,034,050

$ 4,309,050

$ 3,080,850

6

8.92%

$ 3,077,400

$ 4,619,550

EBT

$ 7,889,950

$ 16,130,950

$ 13,225,950

$ 12,430,950

$ 6,939,150

7

8.93%

$ 3,080,850

$ 1,538,700

Tax @ 35%

$ 2,761,483

$ 5,645,833

$ 4,629,083

$ 4,350,833

$ 2,428,703

8

4.46%

$ 1,538,700

$ -

Net Income

$ 5,128,468

$ 10,485,118

$ 8,596,868

$ 8,080,118

$ 4,510,448

Add: Depreciation

$ 4,930,050

$ 8,449,050

$ 6,034,050

$ 4,309,050

$ 3,080,850

OCF

$ 10,058,518

$ 18,934,168

$ 14,630,918

$ 12,389,168

$ 7,591,298

NWC

Beginning Balance

0

$ 6,208,000

$ 10,282,000

$ 8,439,000

$ 7,566,000

Ending Balance @ 20% of Sales Revenue

$ 6,208,000

$ 10,282,000

$ 8,439,000

$ 7,566,000

0

Change in NWC Cash Flow

$ (6,208,000)

$ (4,074,000)

$ 1,843,000

$ 873,000

$ 7,566,000

Cash Flow From Sale of Equipment

Cash Sale Price

$ 5,500,000

Net Book Value

$ 7,696,950

(from MACRS Schedule)

Net Gain or (Loss)

$ (2,196,950)

Taxes @ 35%

$ (768,933)

Cash Sales Price

$ 5,500,000

Add Tax Benefit or Deduct Tax Expense

$ (768,933)

Cash Flow From Sale of Equipment

$ 6,268,933

Project Cash Flows

Initial Investment

$ (34,500,000)

OCF

$ 10,058,518

$ 18,934,168

$ 14,630,918

$ 12,389,168

$ 7,591,298

Change in NWC Cash Flow

(6,208,000)

(4,074,000)

1,843,000

873,000

7,566,000

Cash Flow from Sale of Equipment

6268932.5

Total Project Cash Flows

$ (34,500,000)

$ 3,850,518

$ 14,860,168

$ 16,473,918

$ 13,262,168

$ 21,426,230

1. Compute Payback Period

Year

CF

Cumulative CF

0

$ (34,500,000)

$ (34,500,000)

1

$ 3,850,518

$ (30,649,483)

2

$ 14,860,168

$ (15,789,315)

3

$ 16,473,918

$ 684,603

4

$ 13,262,168

$ 13,946,770

5

$ 21,426,230

$ 35,373,000

2. Compute the Profitability Index

3. Compute Project NPV

4. Compute Project IRR

5. Recommendation (ACCEPT or REJECT):

Why or Why Not?

MACRS Depreciation		$ 34,500,000
Year	MACRS	Depreciation	Net Book Value
1	14.29%	$ 4,930,050	$ 29,569,950
2	24.49%	$ 8,449,050	$ 21,120,900
3	17.49%	$ 6,034,050	$ 15,086,850
4	12.49%	$ 4,309,050	$ 10,777,800
5	8.93%	$ 3,080,850	$ 7,696,950
6	8.92%	$ 3,077,400	$ 4,619,550
7	8.93%	$ 3,080,850	$ 1,538,700
8	4.46%	$ 1,538,700	$ -