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"Shell Star Electronics is a mid-sized electronics manufacturer located in Key West, Florida. The company president is Shelly Coats, who inherited...
"Shell Star Electronics is a mid-sized electronics manufacturer located in Key West, Florida. The company president is Shelly Coats, who inherited the company. The company originally repaired radios and other household appliances when it was founded over 70 years ago. Over the years, the company has expanded, and it is now a reputable manufacturer of various specialty electronic items. Jay McCanless, a recent MBA graduate, has been hired by the company in its finance department.
One of the major revenue-producing items manufactured by SSE is a third generation Personal Digital Assistant (PDA). SSE currently has one PDA model on the market and sales have been excellent. The PDA is a unique item in that it comes in a variety of tropical colors and is preprogrammed to play Jimmy Buffet music. Aging Parrotheads love it. However, as with any electronic item, technology changes rapidly, and the current PDA has limited features in comparison with newer models. SSE spent $750,000 to develop a prototype for a new PDA that has all the features of the existing one, but adds new capabilities such as the ability to serve as a platform for electronic books. . The company has spent a further $200,000 for a marketing study to determine the expected sales figures for the new unit.
SSE can manufacture the new PDA for $86 each in variable costs. Fixed costs for the operation are estimated to run $3 million per year. The estimated sales volume is 70,000, 80,000, 100,000, 85,000, and 75,000 per each year for the next five years, respectively. The unit price of the new PDA/cell/reader will be $250. The necessary equipment can be purchased for $15 million and will be depreciated on a 7-year MACRS schedule. It is believed the value of the equipment in five years will be $3 million.
Net working capital for the PDAs will be 20 percent of sales and will occur simultaneously with the timing of the 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. SSE has a 35 percent corporate tax rate and a 12 percent required return.
Shelly has asked Jay to prepare a report that answers the following questions:
1. What is the payback period of the project?
2. What is the profitability index of the project?
3. What is the IRR of the project?
4. What is the NPV of the project?
5. How sensitive is the NPV to changes in the price of the new unit?
6. How sensitive is the NPV to changes in the quantity sold?
7. Should SSE produce the new unit?
8. Suppose SSE loses sales on its other model because of the introduction of the new model. How would this affect your analysis?"
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