Awesome Audio is a midsized electronics manufacturer located in Wilmington, Delaware. One of the major revenue-producing items manufactured by Awesome Audio is a satellite radio receiver. Awesome Audio currently has one model on the market and sales have been excellent. The existing product has limited capabilities in that it is uniquely tied to a single vendor of satellite radio programming services. However, as with any electronic item, technology changes rapidly, and the single source limits the product’s available market. Awesome Audio spent $750,000 to develop a prototype for a new smartphone that has all the features of the existing one but adds several new features and can accept programed music from a variety of sources. The company has spent a further $200,000 for a marketing study to determine the expected sales figures for the new receiver.
Awesome Audio can manufacture the new receiver for $215 each in variable costs. Fixed costs for the operation are estimated to run $5.1 million per year. The estimated sales volume is 64,000, 106,000, 87,000, 80,000, and 56,000 per year for the next five years, respectively. The unit price of the new receiver will be $495. The new equipment required to produce the receiver would cost $34.5 million and be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $5.5 million.
Net working capital for the satellite radio receiver will be 25 percent of sales and will occur 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. Awesome Audio has a 30 percent corporate tax rate and a required return of 10 percent.
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. Should Awesome Audio produce the new satellite radio receiver? Suppose Awesome Audio loses sales on other models because of the introduction of the new model. How would this affect your analysis?