AB 217 Electronics is a midsized electronics manufacturer located in Melbourne, Florida. The company president is Sherry Jones. When it was founded over 70 years ago, the company originally repaired radios and other household appliances. Over the years, the company expanded into manufacturing and is now a reputable manufacturer of various electronic items. Doug Brown has been hired by the company's finance department.
One of the major revenue-producing items manufactured by AB 217 is a personal digital assistant (PDA). AB 217 currently has one PDA model on the market, and sales have been excellent. The PDA is a unique item in that it comes in a variety of tropical colors and is preprogrammed to play Jimmy Buffett music. However, as with any electronic item, technology changes rapidly, and the current PDA has limited features in comparison with newer models. AB 217 developed a prototype for a new PDA that has all the features of the existing PDA but adds new features such as cell phone capability. The company has performed a marketing study to determine the expected sales figures for the new PDA.
AB 217 can manufacture the new PDA for $200 each in variable costs. Fixed costs for the operation are estimated to run $4.5 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 $340. The necessary equipment can be purchased for $16.5 million and will be depreciated on a 5 year straight-line schedule. Net working capital investment for the PDAs will be $6,000,000 this year. Of course NWC will be recovered at the projects end. AB 217 has a 35 percent corporate tax rate. AB 217’s capital structure is 40% debt with an after-tax cost of 8% and 60% equity costing 16%,
Sherry has asked Doug to prepare a report that answers the following questions:
A. What is AB 217’s WACC, which will be used as the required rate of return for this project?
B. What is the IRR of the project?
C. What is the NPV of the project, based on the WACC (required rate of return)?
D. If you were Doug, how would you answer the questions?