XYZ company spent $750,000 to develop a microchip. The company spent an addition

Question

XYZ company spent $750,000 to develop a microchip. The company spent an additional $200,000 for marketing. XYZ company can manufacture the chip for $205 each in variable costs. Fixed costs for the operations are estimated to run $5.1 million per year. The estimated sales volume is $64,000; $106,000; $87,000; $78,000; and $54,000 per year for the next five years respectively. The unit price per chip will be $485. The necessary equipment can be purchased for $34.5 million and will 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 chip will be 20% of sales and will occur with the timing of the case flows for the year (i.e. there will be no initial outlay for NWC). Changes in NWC will first occur in Year 1 with the first year

Explanation / Answer

Statement of Annual Cash Flows:

_______________

Part A)

Payback Period:

Payback period is the period within which the initial investment will get recovered. For this, we will calculate cumulative cash flows.

Since, the cash flows turno positive in Year 3, the payback period will lie between Year 2 and Year 3. The equation will be:

Payback Period = 2 + (-Cumulative Cash Flow Year 2)/Cash Flow Year 3

Payback Period = 2 + (-(-13,946,315))/15,503,918 = 2.90 Years

_________________

Part B:

Profitability Index is the ratio of present value of cash inflows and initial investment. The formula for calculating present value of cash inflows is:

Present Value of Cash Inflow = Cash Flow Year 1/(1+Required Return)^1 + Cash Flow Year 2/(1+Required Return)^2 + Cash Flow Year 3/(1+Required Return)^3 + Cash Flow Year 4/(1+Required Return)^4 + Cash Flow Year 5/(1+Required Return)^5

___________

Using the cash flows calculated above, we get,

Present Value of Cash Inflows = 5,984,518/(1+12%)^1 + 20,777,168/(1+12%)^2 + 15,503,918/(1+12%)^3 + 14,717,168/(1+12%)^4 + 16,404,298/(1+12%)^5 = $51,603,398.92

Profitability Index = 51,603,398.92/34,500,000 = 1.50

_________________

Part C:

IRR is the minimum rate of return acceptable from a project. IRR can be easily calculated with the use of IRR function in EXCEL/Financial Calculator. The general formula for calculating IRR is:

NPV = 0 = - Cash Flow Year 0 + Cash Flow Year 1/(1+IRR)^1 + Cash Flow Year 2/(1+IRR)^2 + Cash Flow Year 3/(1+IRR)^3 + Cash Flow Year 4/(1+IRR)^4 + Cash Flow Year 5/(1+IRR)^5

___________

Using the cash flows calculated above, we get,

___________

Part D)

NPV is the difference between the present value of cash inflows and cash outflows. The formula for calculating NPV is:

NPV = Present Value of Cash Inflows - Present Value of Cash Outflows

___________

Using the values calculated above, we get,

NPV = 51,603,398.92 - 40,708,000 = $10,895,398.92

Year 0 1 2 3 4 5 Initial Investment -34,500,000 Sales in Units 64,000 106,000 87,000 78,000 54,000 Sale Price 485 485 485 485 485 Revenue (Sales in Units*Selling Price) 31,040,000 51,410,000 42,195,000 37,830,000 26,190,000 Costs: Variable cost (Units*Variable Cost Per Unit) 13,120,000 21,730,000 17,835,000 15,990,000 11,070,000 Fixed Cost 5,100,000 5,100,000 5,100,000 5,100,000 5,100,000 Total Cost 18,220,000 26,830,000 22,935,000 21,090,000 16,170,000 Total Revenue 31,040,000 51,410,000 42,195,000 37,830,000 26,190,000 Total Cost Incurred 18,220,000 26,830,000 22,935,000 21,090,000 16,170,000 Net Cash Flow after Depreciation 12,820,000 24,580,000 19,260,000 16,740,000 10,020,000 Depreciation (Cost of Equipment*Annual Depreciation MACRS Rate) 4,930,050 8,449,050 6,034,050 4,309,050 3,080,850 Net Cash Flow after Depreciation 7,889,950 16,130,950 13,225,950 12,430,950 6,939,150 Tax @ 35% 2,761,483 5,645,833 4,629,083 4,350,833 2,428,703 Net Cash Flow After Tax 5,128,468 10,485,118 8,596,868 8,080,118 4,510,448 Add Depreciation 4,930,050 8,449,050 6,034,050 4,309,050 3,080,850 Net Cash Flow from Operations 10,058,518 18,934,168 14,630,918 12,389,168 7,591,298 Working Capital: Beginning Working Capital (Sales*20%) 6,208,000 10,282,000 8,439,000 7,566,000 5,238,000 Ending Working Capital -6,208,000 10,282,000 8,439,000 7,566,000 5,238,000 0 Net Change -4,074,000 1,843,000 873,000 2,328,000 5,238,000 After Tax Salvage Value (Market Value*(1-Tax Rate)) 3,575,000 Net Cash Flows -$40,708,000 $5,984,518 $20,777,168 $15,503,918 $14,717,168 $16,404,298

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