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Electronics Unlimited Case Study

Electronics Unlimited is considering introducing a new product that is expected to generate sales of $10 million in year 1, increasing to $13 million in years 2 and 3, then decreasing to $8.67 million in year 4 and $4.33 million in year 5. It would cost $500,000 for new production equipment and require an initial investment in net working capital of 27% of the change in annual sales. The product is estimated to have a positive net present value at a 20% cost of capital and an internal rate of return above 20%, so EU should introduce the new product.

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2K views

Electronics Unlimited Case Study

Electronics Unlimited is considering introducing a new product that is expected to generate sales of $10 million in year 1, increasing to $13 million in years 2 and 3, then decreasing to $8.67 million in year 4 and $4.33 million in year 5. It would cost $500,000 for new production equipment and require an initial investment in net working capital of 27% of the change in annual sales. The product is estimated to have a positive net present value at a 20% cost of capital and an internal rate of return above 20%, so EU should introduce the new product.

Uploaded by

HinhHinh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Electronics Unlimited (EU)was considering the introduction of a new product that had 5

years of life and was expected to generate sales in Year 1 through 5 as the following:
Year 1
Year 2
Year 3
Year 4
Year 5
$10,000, 000 $13,000,000 $13,000,000 $8,667,000 $4,333,000
No material levels of revenues or expenses associated with the new product were expected
after five years of sales. Based on past experience, cost of sales for the new product was
expected to be 60% of total annual sales revenue during each year of its life cycle. Selling,
general and administrative expenses were expected to be 23.5% of total annual sales. Taxes
on profits generated by the new product would be paid at a 40% rate.
To launch the new product, EU would have to incur immediate cash outlays of two types.
First, it would have to invest $500,000 in specialized new production equipment. This capital
investment would be fully depreciated on a straight-line basis over the five-year anticipated
life of the new product. There would be no salvage value left for the equipment at the end
of its depreciable life. No further fixed capital expenditures were required after the initial
purchase of equipment.
Second, additional investment in net working capital to support sales would have been
made. EU generally required 27 cents of net working capital to support each dollar of sales.
That is, change in net working capital in 27% of change in sales. As a practical matter, the
buildup of working capital would have to be made at the beginning of the sales year in
question (or, equivalently, by the end of the previous year). For example, Sales in year 2
were expected to be $13,000 million, $3,000 million increase from Year 1s sales, so a
buildup of working capital of 27% of $3,000 should be made at the end of Year 1. i.e., the
change in net working capital for year 1 is $3,000 million. At the end of the new products
life cycle, all remaining net working capital would be liquidated and the cash recovered.
Finally, EU expected to incur tax-deductible introductory expenses of $200,000 in the first
year of the new products sales. Such cost would not be recurring over the products life
cycle. Approximately $1,000,000 had already been spent developing and testing marketing
the new product.
1. Estimate the new products cash flows.
2. Assuming a 20% cost of capital, what is the products net present value? What is its
internal rate of return?
3. Should EU introduce the new product? Explain why?

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