Investment Decision Essay

Published: 2020-02-21 22:22:12
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Category: Corporate tax

Type of paper: Essay

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Tianfu Electronics Ltd is a midsized electronics manufacturer located in Chengdu, China. The company president is Dr. Wang Datong, a graduate from Tsinghua University, who founded the company 20 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. Meng Xiaolan, a recent MBA graduate from Fudan University, has been hired by the companys finance department. One of the major revenue-producing items manufactured by Tianfu is a personal digital assistant (PDA).

Tianfu 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 traditional and modern music. However, as with any electronic item, technology changes rapidly, and the current PDA has limited features in comparison with newer models. Tianfu spent 1,815,000 yuan (RMB) to develop 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 spent a further 390,000 yuan for a marketing study to determine the expected sales figures for the new PDA. Tianfu can manufacture the new PDA for 150 yuan each in variable costs. Fixed costs for the operation are estimated to run 4. 5 million yuan 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 yuan. The necessary equipment can be purchased for 19. 5 million yuan and will be depreciated on a sevenyear schedule, with the depreciation percentages for the first five years being.

It is believed that the market value of the equipment in five years will be 3. 3 million yuan. As previously stated, Tianfu currently manufactures a PDA. Production of the existing model is expected to be terminated in two years. If Tianfu does not introduce the new PDA, sales will be 80,000 unites and 60,000 units for the next two years, respectively. The price of the existing PDA is 280 yuan per unit, with variable costs of 120 yuan each and fixed costs of 1. 8 million yuan per year.

If Tianfu does introduce the new PDA, sales of the existing PDA will fall by 15,000 units per year, and the price of the existing units will have to be lowered to 240 yuan each. Net working capital for the PDAs will be 20 percent of sales and will occur with the timing of the cash flows for the year; for example, there is no initial outlay for NWC, but changes in NWC will first occur in year 1 with the first years sales. Tianfu has a 25 percent corporate tax rate and a 12 percent required return. a. Wang Datong has asked Meng Xiaolan to prepare a report and determine the IRR and NPV of the project.

What should Xiaolan propose for the decision? b. Tianfu has an idle piece of equipment that can be used for the new project, which, if used, can reduce the purchase of necessary new equipment and its salvage value in five years by 20%. The idle equipment currently has a book value of 4. 05 million yuan, and is to be depreciated to zero in four years in the straight-line method. The current market value of the idle equipment is 3. 735 million yuan and will have no salvage value in five years. What are the IRR and NPV if the idle equipment is used? Compare the difference in your results between (a) and (b) and briefly discuss.

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