Ellen was recently promoted to the position of Financial Manager in EHCH Mobiles. She initially worked as a junior financial executive for 3 years before being promoted. Ellen has had no prior experience dealing with significant financial matters and doesn't want to make any mistakes. Therefore, Ellen requires a detailed report from you, a talented group of MBA students, before finalizing any significant decisions.

EHCH Mobiles has been in the mobile phone industry for the past two decades. The mobile phones produced by EHCH Mobiles have been compared to superior brands such as Nokia, Samsung. However, sales for their most successful brands had been declining for newer brands produced by these competitors in the past years. Therefore, the company is now considering the launch of a new 5G mobile phone. Experience from the sale of previous models has shown that the expected life of the new model is four years.

The company’s research and development division, which functions on an annual budget of $50,000,000, has developed a prototype of the new model. A further investment of $800,000,000 will be required at the start of year 1 for a new manufacturing facility to put the new model into production. The new manufacturing facility will be expected to have a residual value of $125,000,000 at the end of four years.

As the new model is being sold in the market, the company will expect to incur certain operating costs. The new manufacturing facility will exclusively produce the 5G model. The total fixed manufacturing costs will be $600,000,000 annually, excluding depreciation. It is also anticipated that an additional $200,000,000 will be spent in year 1 and $150,000,000 in years 2 and 3 on further development and marketing of the new model. The new model is to be marketed at a 7 premium price of $300 per unit and is expected to remain the same throughout its life. Annual
sales will amount to a total of 2,000,000 units.

The company is considering a large-scale convention at the end of year 1 to promote the new model to attract customers. The convention has been estimated to incur a cost of $5,000,000 and an additional $1,000,000 for marketing. The company believes that sales will likely boost to 3,000,000 units per annum from year 2 onwards.

Ellen has been tasked to evaluate the proposed expansion from a financial perspective. The company generally evaluates projects of this nature upon completion as well. The company uses a cost of capital of 7% per annum to evaluate projects of this type.

Required:

Prepare a report on the following for Ellen;

a) Calculate the net present value (NPV) of the project. Workings should be shown in $000.

b) Determine the profitability index (PI) and payback period of the project.

c) Analyze why the project's payback period is not the best method to assess the project from a financial perspective AND how the best method should be determined.

d) Interpret TWO reasons why EHCH Mobiles may want to calculate the profitability index of this project even though NPV is the theoretically superior method of capital budgeting.

e) Justify TWO reasons and TWO benefits of EHCH Mobiles carrying out a post completion audit of this project.

Answer rating: 100% (QA)

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