Jamnic Digital Automotive manufactures a variety of electronic products. The com
ID: 2749962 • Letter: J
Question
Jamnic Digital Automotive manufactures a variety of electronic products. The company is considering introducing its most exciting product; a new digital instrument panel for customized classic cars. This panel allows the car owner to customize the complete set of instruments for the vehicle. Output display may be analog or digital, with many styles of display using apps that may be purchased, downloaded, and installed with a micro SD card. Your analysts have provided you with the following forecast information for the “Fully Customizable Instrument Panel” (FCIP):
The project has an anticipated economic life of 5 years.
The company will have to purchase a new machine to produce the new product. The machine has an up-front cost (t = 0) of $2,107,000.
The equipment will be depreciated using the MACRS method using the ½ year convention with a 5 year class life:
t = 1 20.00%
t = 2 32.00
t = 3 19.20
t = 4 11.52
t = 5 11.52
t = 6 5.76
At the end of the project, the expected value (salvage value) of the equipment is $925,000.
If the company goes ahead with the proposed product, it will have an effect on the company’s net operating working capital. At the outset, t = 0, inventory will increase by $136,000 , accounts payable will increase by $52,000, and accounts receivable will increase by $41,500. At t = 5, the net operating working capital will be recovered after the project is completed.
The new product is expected to generate incremental sales revenue as follows:
Year 1: $1,200,000
Year 2: 2,500,000
Year 3: 3.250,000
Year 4: 3,100,000
Year 5: 1.575,000
The operating costs, excluding depreciation, are expected to be 59% of the annual sales.
The new product is expected to reduce the after-tax cash flows of the company’s other existing products by $175,000 a year (t = 1, 2, 3, 4, and 5).
The company’s tax rate is 40 percent.
Jamnic considers this to be a higher risk project.
The before tax cost of debt (rd) for Jamnic s 5.12%, and the common stock beta is 1.43. The current capital structure (market value) is as follows:
Jamnic Digital Automotive.
Debt $2,450,000
Equity 7,350,000
$9,800,000
Jamnic Digital Automotive uses the firm’s WACC for average risk projects, it adds 2% for high risk projects. For low risk projects it uses the WACC less 2%.
Your analysts also compiled current market information:
Market risk premium (RPm): 4%
Risk-free rate (rRF): 2.25%
Given the above information: (Show your work and calculations)
2. Read all parts (a, b, c, d) first. (Show your calculations)
a. (5 points) What is the initial net cash flow (t=0) for the project?
b. (8 points) What are the operating cash flows for time periods 1 through 6?
c. (5 points) What is the total terminal cash flow for the project, recognizing the sale of the equipment and the liquidation of NOWC? (NOT the operating cash flows you found in 2.b.)
d. (5 points) On the timeline table below, show the total cash flow amount for each period based on the work you did above in a, b, c, and d.
Period
0
1
2
3
4
5
6
Cash Flow
Period
0
1
2
3
4
5
6
Cash Flow
Explanation / Answer
Initial Cash Outflow = Investment in machinery + Investment in working capital
Investment In Working Capital = Increase In inventory – Increase in accounts payable + increase in accounts receivable = 136000 – 52000 + 41500 = 125500
Initial Cash outflow = 2107000 + 125500 = 2232500
Cash Inflows From Operations:
[Increase In Sales * ( 1 – Operating Cost Ratio) – Loss in sales of existing products] * ( 1 – tax) + Tax Saving On depreciation
T = 1 : (1200000 * ( 1-0.59) – 175000) (1 – 0.4) + 0.4 * 20% * 2107000 = 358760
T = 2 : (2500000 * ( 1-0.59) – 175000) (1 – 0.4) + 0.4 * 32% * 2107000 = 779696
T = 3 : (3250000 * ( 1-0.59) – 175000) (1 – 0.4) + 0.4 * 19.2% * 2107000 = 856317.60
T = 4 : (3100000 * ( 1-0.59) – 175000) (1 – 0.4) + 0.4 * 11.52% * 2107000 = 754690.56
T = 5 : (1575000 * ( 1-0.59) – 175000) (1 – 0.4) + 0.4 * 11.52% * 2107000 = 379540.56
Terminal Operating Cash Flow = Salvage Value - Tax On ( Salvage Value – Book Value ) + Working Capital Investment
Terminal Operating Cash Flow = 925000 – 0.40( 925000 – 5.76% of 2107000) + 125500 = 729045.28
Period
0
1
2
3
4
5
Cash Flow
-2232500
+358760
+779696
+856317.60
+754690.56
+379540.56+729045.28 = 1108585.84
Period
0
1
2
3
4
5
Cash Flow
-2232500
+358760
+779696
+856317.60
+754690.56
+379540.56+729045.28 = 1108585.84
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