Table 1 Year 0 1 2 3 4 5 Incremental Earnings Forecast ($000) 1 Sales - 26,000 26,000 26,000 26,000 - 2 Cost of Goods Sold - (11,000) (11,000) (11,000) (11,000) - 3 Gross Profits - 15,000 15,000 15,000 15,000 - 4 Selling, General, and Administrative - (2,800) (2,800) (2,800) (2,800) - 5 Research and Development (15,000) - - - - - 6 Depreciation - (1,500) (1,500) (1,500) (1,500) (1,500) 7 EBIT (15,000) 10,700 10,700 10,700 10,700 (1,500) 8 Income Tax at 40% 6,000 (4,280) (4,280) (4,280) (4,280) 600 9 Unlevered Net Income (9,000) 6,420 6,420 6,420 6,420 (900)

After looking at the projections of the HomeNet project, you decide that they are not realistic. It is unlikely that sales will be constant over the four-year life of the project.Furthermore, other companies are likely to offer competing products, so the assumption that the sales price will remain constant is also likely to be optimistic. Finally, as production ramps up, you anticipate lower per unit production costs resulting from economies of scale. Therefore, you decide to redo the projections under the followingassumptions: Sales of 50,000 units in year 1 increasing by 50,000 units per year over the life of the project, a year 1 sales price of $260/unit, decreasing by 11% annually and a year 1 cost of $120/unit decreasing by 21% annually. In addition, new tax laws allow you to depreciate the equipment, costing $7.5 million over three rather than five years using straight-line depreciation.

a. Keeping the underlying assumptions in Table (1 ) that research and development expenditures total $15million in year 0 and selling, general, and administrative expenses are $2.8million per year, recalculate unlevered net income. (That is, reproduce Table 1 under the new assumptions given above. Note that we are ignoring cannibalization and lost rent.)

b. Recalculate unlevered net income assuming, in addition, that each year 20%

of sales comes from customers who would have purchased an existing Cisco router for $100/unit and that this router costs

$60/unit to manufacture.