CASE STUDY 2
Spring 2022 B2
As the newly hired analyst for the corporate offices of Illuminated Electronics Corporation (IEC), you must prepare an analysis of a capital budgeting proposal.
Proposal 1 – PPD
IEC has just developed a new electronic device (called the PPD) and it believes it 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 $315,000 and have a six-year useful life. After six years, it would have a salvage value of about $15,000.
B) Sales in units over the next six years are projected to be as follows:
Sales in Units
C) Production and sales of the device would require working capital of $60,000 to finance accounts receivable, inventories, and day-to-day cash needs. This working capital would be released at the end of the project’s life.
D) The devices 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 $135,000 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 Yearly Advertising
G) The company’s required rate of return in 14%.
Proposal 2 – NED
One of your colleagues has provided an analysis of a competing proposal and concluded the following:
NPV = $120,000; IRR = 15.5%; Payback Period = 3.5 years, Profitability Index = 1.25
1) Compute the net cash inflow (incremental contribution margin minus incremental fixed expenses) anticipated from the sale of the PPDs for each year over the next six years.
2) Using the data computed (1) 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 “best” and “worst” case scenarios using the following assumptions:
a) Best Case – Projected sales expectations increase by 10%, required rate of return falls to 7%.
b) Worst Case – Projected sales decreases by 10%, required rate of return increases to 15%.
4) Write a memo to the CFO of IEC providing your analysis and recommendation regarding the PPDs. Be sure to compare your results to the competing proposal. Include a strong recommendation for or against the acceptance of the new PPDs into IEC’s product line.