You are evaluating the HomeNet project under the following assumptions: You depr
ID: 2773604 • Letter: Y
Question
You are evaluating the HomeNet project under the following assumptions: You depreciate the equipment, costing $7.5 million, over three years using straight-line depreciation. Research and development expenditures total $15 million in year 0 and selling, general, and administrative expenses are $2.8 million per year (assuming there is no cannibalization). Also assume HomeNet will have no incremental cash or inventory requirements (products will be shipped directly from the contract manufacturer to customers). However, receivables related to HomeNet are expected to account for 15% of annual sales, and payables are expected to be 15% of the annual cost of goods sold. Under these assumptions and assuming a cost of capital of 12%, calculate:
a. The break-even annual sales price decline if: sales of 50,000 units in year 1 increase by 52,000 units per year over the life of the project, the year 1 sales price is $260/unit, and the year 1 cost of $120/unit decreases by 20% annually. (see chart)
The break-even annual sales price decline is ( ? ) %. (round to two decimal places)
b. The break-even annual unit sales increase if: sales are 50,000 units in year 1, the year 1 sales price of $260/unit, decrease by 21.8% annually and the year 1 cost of $120/unit decreases by 20% annually. (see chart)
The break-even annual sales increas is ( ? ) units. (round to nearest integer)
Year
0
1
2
3
4
5
HomeNet
Unit Sales ($000s)
52
50
102
154
206
-
Sales Price ($/unit)
21.80%
260
203.32
159
124.34
-
Cost of Goods Sold ($/unit)
20%
120
96
76.8
61.44
-
Operating Expenses ($000s)
-
Hardware & Software Develop.
-15,000
-
Marketing & Technical Support
-2,800
-2,800
-2,800
-2,800
-
Capital Expenditures
-
Lab Equipment
-7,500
-
Depreciation
33%
33%
33%
-
-
Marginal Corporate Tax Rate
40%
40%
40%
40%
40%
-
Year
0
1
2
3
4
5
Incremental Earning Forcast ($000s)
1.) Sales
-
13,000
20,739
24,486
25,614
-
2.) Cost of Goods Sold
-
-6,000
-9,792
-11,827
-12,657
-
3.) Gross Profits
-
7,000
10,947
12,659
12,957
-
4.) Selling, General, and Administrative
-
-2,800
-2,800
-2,800
-2,800
-
5.) Research and Development
-15,000
-
-
-
-
-
6.) Depreciation
-
-2,500
-2,500
-2,500
-
-
7.) EBIT
-15,000
1,700
5,647
7,359
10,157
-
8.) Income Tax at 40%
6,000
-680
-2,259
-2,944
-4,063
-
9.) Unlevered Net Income
-9,000
1,020
3,388
4,415
6,094
-
Free Cash Flow ($000s)
10.) Plus: Depreciation
2,500
2,500
2,500
11.) Less: Capital Expenditures
-7,500
12.) Less: Increases in NWC
-1,050
-592
-257
-44
13.) Free Cash Flow
-16,500
2,470
5,296
6,658
6,050
1,943
Year
0
1
2
3
4
5
Net Present Value ($000s)
1.) Free Cash Flow
-16,500
2,470
5,296
6,658
6,050
1,943
2.) Project Cost of Capital 12%
3.) Discount Factor
1.000
0.8929
0.7972
0.7118
0.6355
0.5674
4.) PV of Free Cash Flow
-16,500
2,205
4,222
4,739
3,845
1,102
Question A is asking for one number and it needs to be a percentage.
Question B is asking for one number
Year
0
1
2
3
4
5
HomeNet
Unit Sales ($000s)
52
50
102
154
206
-
Sales Price ($/unit)
21.80%
260
203.32
159
124.34
-
Cost of Goods Sold ($/unit)
20%
120
96
76.8
61.44
-
Operating Expenses ($000s)
-
Hardware & Software Develop.
-15,000
-
Marketing & Technical Support
-2,800
-2,800
-2,800
-2,800
-
Capital Expenditures
-
Lab Equipment
-7,500
-
Depreciation
33%
33%
33%
-
-
Marginal Corporate Tax Rate
40%
40%
40%
40%
40%
-
Year
0
1
2
3
4
5
Incremental Earning Forcast ($000s)
1.) Sales
-
13,000
20,739
24,486
25,614
-
2.) Cost of Goods Sold
-
-6,000
-9,792
-11,827
-12,657
-
3.) Gross Profits
-
7,000
10,947
12,659
12,957
-
4.) Selling, General, and Administrative
-
-2,800
-2,800
-2,800
-2,800
-
5.) Research and Development
-15,000
-
-
-
-
-
6.) Depreciation
-
-2,500
-2,500
-2,500
-
-
7.) EBIT
-15,000
1,700
5,647
7,359
10,157
-
8.) Income Tax at 40%
6,000
-680
-2,259
-2,944
-4,063
-
9.) Unlevered Net Income
-9,000
1,020
3,388
4,415
6,094
-
Free Cash Flow ($000s)
10.) Plus: Depreciation
2,500
2,500
2,500
11.) Less: Capital Expenditures
-7,500
12.) Less: Increases in NWC
-1,050
-592
-257
-44
13.) Free Cash Flow
-16,500
2,470
5,296
6,658
6,050
1,943
Year
0
1
2
3
4
5
Net Present Value ($000s)
1.) Free Cash Flow
-16,500
2,470
5,296
6,658
6,050
1,943
2.) Project Cost of Capital 12%
3.) Discount Factor
1.000
0.8929
0.7972
0.7118
0.6355
0.5674
4.) PV of Free Cash Flow
-16,500
2,205
4,222
4,739
3,845
1,102
Explanation / Answer
a. The break-even annual sales price decline if: sales of 50,000 units in year 1 increase by 52,000 units per year over the life of the project, the year 1 sales price is $260/unit, and the year 1 cost of $120/unit decreases by 20% annually. (see chart) The break-even annual sales price decline is ( ? ) %. (round to two decimal places) Solution: Year-1 Year-2 Year-3 Year-4 Year-5 Break even Sales $ 10,214,285.7 $ 15,724,524.79 $ 20,948,373.93 $ 25,450,567.40 458,476,791.86 Break even Sales in units 39286 77339 131754 204693 4715383 Break even Sale price $ 260.00 $ 203.32 $ 159.00 $ 124.34 97.23002179 Decrease from preceeding year to that of the previous year $ (56.68) $ (44.32) $ (34.66) $ (27.11) $ (97.23) Comments: The break-even annual sales price decline is approximately 21.71 %. b. The break-even annual unit sales increase if: sales are 50,000 units in year 1, the year 1 sales price of $260/unit, decrease by 21.8% annually and the year 1 cost of $120/unit decreases by 20% annually. (see chart) The break-even annual sales increas is ( ? ) units. (round to nearest integer) Solution: Year-2 Year-1 Break even annual Sales increase Break even sales $ 15,724,524.79 $ 10,214,285.7 $ 5,510,239.08 Break even Sales in units 77339 39286 38053 Units Comments:Due to decrease of sale price by 21.8% annually and the Cost of Goods Sold by 20% anually Comments:The break-even annual sales increases by 38053 units when compared with that of the Year-2 to Year-1 Year-3 Year-2 Break even annual Sales increase Break even sales $ 20,948,373.93 $ 15,724,524.79 $ 5,223,849.14 Break even Sales in units 131754 77339 54415 Units Comments:Due to decrease of sale price by 21.8% annually and the Cost of Goods Sold by 20% anually Comments:The break-even annual sales increases by 54415 units when compared with that of the Year-3 to Year-2
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