Confederation Electronics is a mid-sized electronic s manufacturer located in Calgary, Alberta. Jennifer Reed, the company’s president, inherited the firm several years ago. Confederation 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.
One of the major revenue-producing items manufactured by Confederation Electronics is a smartphone called Spark. It is the only model of smartphone they produce. They launched the model five years ago by gifting them to the artists at that year’s Juno Awards. Reviews have always been very positive and it has since become the phone of choice for many artists on the Canadian music scene and hence, very popular with their fans as well.
However, as with any electronic item, technology changes rapidly, and the current Spark has limited features in comparison with newer models offered by competitors. Confederation Electronics has spent $750,000 to develop a prototype for an updated version (Spark2) that surpasses everything currently on the market and they’ve already spent a further $200,000 for a marketing study to determine expected sales figures if they decide to proceed.
Confederation Electronics can manufacture the Spark2 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 will be $250.
- The necessary equipment can be purchased for $15 million and falls in CCA Class 43, with a 30 percent rate. When the project is completed, Confederation Electronics will have other assets remaining in that CCA asset class. It is believed the value of the equipment in five years will be $3 million.
Net working capital for the Spark2 project will be 20 percent of sales and will occur with the timing of the cash flows for each year (i.e., no initial outlay for NWC). Changes in NWC will thus first occur in Year 1 with the first year’s sales. Confederation Electronics has a 35 percent corporate tax rate and a 12 percent required return.
Short Answer (50 marks)
- What is the payback period of the project? (5 marks)
- What is the profitability index of the project? (5 marks)
- What is the IRR of the project? (5 marks)
- What is the NPV of the project? (5 marks)
- How sensitive is the project NPV to change in the price of the new Spark2? (10 marks)
- How sensitive is the project NPV to changes in the quantity sold? (10 marks)
- Should Confederation Electronics produce the Spark2? Why? (5 marks)
- Suppose Confederation Electronics loses sales on its other products because of the introduction of the Spark2. How would this affect your analysis? (5 marks)