Summer 2021 Block 1 Case Study 2 Solution CASE STUDY 2 Fall 2021 Analysis of alternative proposals Proposal 1 NED Life span 1 3 Fixed costs As the newly hired analyst for the corporate offices of Illuminated Electronics Corporation (IEC), you must prepare an analysis of a capital budgeting proposal. IEC has just developed a new electronic device (called the NED) it believes will have broad market appeal. The company has performed marketing and cost studies that revealed the following information: A) New equipment would have to be acquired to produce the device. The equipment would cost $S350,000 and would have a life span of 6 years and a salvage value equal to $$17,500. B) Sales of new NEDs in units over the next six years are projected to be as follows: Variables Equipment $350,000 6 Years Year Sales in Units Salvage 17,500 8,500 Working Cap $ 65,000 2 12,000 Selling Price $ 35 18,250 Unit Cost $ 15 4-6 22,500 $ 140,000 Rate of Return 12% C) Production and sales of the device would require working capital of $65,000 to finance accounts receivable, inventories, and day-to-day cash needs. D) The NEDs would sell for $ 35 each; variable costs for production, administration, and sales would be $15 per unit. E) Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $140,000 per year. (Depreciation is based on cost less salvage value.) F) To gain rapid entry into the market, the company would have to advertise heavily. The advertising costs would be: Amount of Year Yearly Advertising 1-2 $125,000 $135,000 4-6 $120,000 3 G) The company's required rate of return is 12% Proposal 2 PPD One of your colleagues has provide an analysis of a competing proposal and concluded the following: Proposal 2 PPD: NPV = $120,000, IRR = 15.5%, Payback Period = 3.5 years, Profitability Index = 1.25 Required: = 1) Compute the net cash inflow (incremental contribution margin minus incremental fixed expenses) anticipated from the sale of the NEDs for each year over the next six years. Summer 2021 Block 1 Case Study 2 Solution 2) Using the data computed in (1) above and other data provided in the problem, determine the net present value, internal rate of return, payback period and profitability index of the proposed investment. 3) Using the analysis performed in #2, prepare a best and worst case scenario using the following assumptions: Best case: Projected sales expectations increase by 10%, required rate of return falls to 7%. Worst case: Projected sales decrease by 10%, required rate of return increases to 20%. ||4) Write a memo to the CFO of IEC providing your analysis and recommendation regarding the NEDs. Be sure to compare your results to the competing proposal. Be sure to include a strong recommendation for or against the acceptance of the new NEDs into IEC's product line. Summer 2021 Block 1 Case Study 2 Solution CASE STUDY 2 Fall 2021 Analysis of alternative proposals Proposal 1 NED Life span 1 3 Fixed costs As the newly hired analyst for the corporate offices of Illuminated Electronics Corporation (IEC), you must prepare an analysis of a capital budgeting proposal. IEC has just developed a new electronic device (called the NED) it believes will have broad market appeal. The company has performed marketing and cost studies that revealed the following information: A) New equipment would have to be acquired to produce the device. The equipment would cost $S350,000 and would have a life span of 6 years and a salvage value equal to $$17,500. B) Sales of new NEDs in units over the next six years are projected to be as follows: Variables Equipment $350,000 6 Years Year Sales in Units Salvage 17,500 8,500 Working Cap $ 65,000 2 12,000 Selling Price $ 35 18,250 Unit Cost $ 15 4-6 22,500 $ 140,000 Rate of Return 12% C) Production and sales of the device would require working capital of $65,000 to finance accounts receivable, inventories, and day-to-day cash needs. D) The NEDs would sell for $ 35 each; variable costs for production, administration, and sales would be $15 per unit. E) Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $140,000 per year. (Depreciation is based on cost less salvage value.) F) To gain rapid entry into the market, the company would have to advertise heavily. The advertising costs would be: Amount of Year Yearly Advertising 1-2 $125,000 $135,000 4-6 $120,000 3 G) The company's required rate of return is 12% Proposal 2 PPD One of your colleagues has provide an analysis of a competing proposal and concluded the following: Proposal 2 PPD: NPV = $120,000, IRR = 15.5%, Payback Period = 3.5 years, Profitability Index = 1.25 Required: = 1) Compute the net cash inflow (incremental contribution margin minus incremental fixed expenses) anticipated from the sale of the NEDs for each year over the next six years. Summer 2021 Block 1 Case Study 2 Solution 2) Using the data computed in (1) above and other data provided in the problem, determine the net present value, internal rate of return, payback period and profitability index of the proposed investment. 3) Using the analysis performed in #2, prepare a best and worst case scenario using the following assumptions: Best case: Projected sales expectations increase by 10%, required rate of return falls to 7%. Worst case: Projected sales decrease by 10%, required rate of return increases to 20%. ||4) Write a memo to the CFO of IEC providing your analysis and recommendation regarding the NEDs. Be sure to compare your results to the competing proposal. Be sure to include a strong recommendation for or against the acceptance of the new NEDs into IEC's product line