Diamond Electronics, Inc is a leading producer of batteries, which are used in a
ID: 2804806 • Letter: D
Question
Diamond Electronics, Inc is a leading producer of batteries, which are used in a wide variety of products and known for its power and durability. The sales have been excellent; however, as with any electronic item, technology changes rapidly, and the current batteries have limited features in comparison with newer models. Recently, the CEO of Diamond Electronics is planning an expansion of the Battery Testing Center (BTC) to improve its technical capability and capacity to comfortably house personnel. The BTC was built in the 1960s to serve as a laboratory and testing facility for a variety of battery-related applications. Diamond Electronics spent $5million to develop a new LED (light-emitting diodes) battery that has all the features of the existing LED battery, but adds new features such as automotive application. The company has spent a further $2million for a marketing study to determine the expected sales figures for the new LED battery. The necessary equipment to manufacture the new LED battery can be purchased for $10million and will be depreciated on a seven-year MACRS schedule. The after-tax salvage value of the equipment in five years will be $1 million. The net working capital to manufacture the new LED battery is estimated to be $4.5 million and will occur from year 0 to year 4. The company also projects to incur $900,000 financing costs. Diamond Electronics can manufacture the new LED battery for $86 each in variable costs. 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 LED battery will be $250. Diamond Electronics has a 35% corporate tax rate and a 15% required return. The operating cash flows are estimated to be $3,295,248, $5,639,298, $10,435,048, $8,293,798, and $6,853,208 for the next five years, respectively. Jay McCanless, a recent business graduate, has been hired by the company’s finance department. He gathers relevant data and forecasts the incremental cash flows of the new project. Jay was asked to prepare a report that answers the following questions:
1. What are the relevant cash flows that should be used to analyze this project?
2. Could you propose three investment criteria to evaluate this project? Why do you choose these criteria?
3. Should Diamond Electroincs manufacture the new LED battery? Based on your answers to questions 1 and 2, please evaluate this project and give recommendations.
Explanation / Answer
Relevant cashflows
Particulars/Year
0
1
2
3
4
5
Cash outflows
Cost of equipment
10000000
-
-
-
-
-
Working capital
4500000
-
-
-
-
-
Financing cost
900000
-
-
-
-
-
Cash outflows
15400000
-
-
-
-
-
Sale units
-
70000
80000
100000
85000
75000
Contribution
-
164
164
164
164
164
Total contribution
-
11480000
13120000
16400000
13940000
12300000
(-)Depreciation
-
1429000
2449000
1749000
893000
892000
EBT
-
10051000
10671000
14651000
13047000
11408000
(-) Tax 35%
-
3517850
3734850
5127850
4566450
3992800
EAT
-
6533150
6936150
9523150
8480550
7415200
Annual cash inflows = Eat + depreciation
-
7962150
9385150
11272150
9373550
8307200
(+) Salvage value
-
1000000
(+)Working capital
-
4500000
Total cash flows
-
7962150
9385150
11272150
9373550
13807200
Calculation of depriciation
Year
Amount
Rate of dep.
Depreciation
1
10000000
14.29
1429000
2
10000000
24.49
2449000
3
10000000
17.49
1749000
4
10000000
12.49
1249000
5
10000000
8.93
893000
6
10000000
8.92
892000
7
10000000
8.93
893000
8
10000000
4.46
446000
2. Three investment criteria are NPV, IRR and Discounted payback method to evaluate the project . These three criteria use discounting of cashflows to evaluate the project and therefore are good.
3) Calculation of NPV
Year
Total cash flows
Pvif 15%
Present value
0
-15400000
1
-1.5E+07
1
7962150
0.8696
6923886
2
9385150
0.7561
7096112
3
11272150
0.6575
7411439
4
9373550
0.5718
5359796
5
13807200
0.4972
6864940
NPV
18256172
NPV is positive so project should be accepted.
note: For PVif values refer PVIF table.
Particulars/Year
0
1
2
3
4
5
Cash outflows
Cost of equipment
10000000
-
-
-
-
-
Working capital
4500000
-
-
-
-
-
Financing cost
900000
-
-
-
-
-
Cash outflows
15400000
-
-
-
-
-
Sale units
-
70000
80000
100000
85000
75000
Contribution
-
164
164
164
164
164
Total contribution
-
11480000
13120000
16400000
13940000
12300000
(-)Depreciation
-
1429000
2449000
1749000
893000
892000
EBT
-
10051000
10671000
14651000
13047000
11408000
(-) Tax 35%
-
3517850
3734850
5127850
4566450
3992800
EAT
-
6533150
6936150
9523150
8480550
7415200
Annual cash inflows = Eat + depreciation
-
7962150
9385150
11272150
9373550
8307200
(+) Salvage value
-
1000000
(+)Working capital
-
4500000
Total cash flows
-
7962150
9385150
11272150
9373550
13807200
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