You are the CEO of H-Robot Incorporated (HRI), which is a world leader in the robotics industry. Your company produces industrial robots which perform routine assembly line tasks. But due to severe competition, you are concerned about the future growth of HRI. Therefore, your R&D department is working on a new business line, to produce household robots designed to function as a maid. This R&D effort has now reached a stage where a decision should be made on whether to initiate this new production line.
➢ Your Marketing Department has plans to sell robots to households with working mothers. The marketing Vice President believes that annual sales will be 200,000 units if the robots are priced at $400 each.
➢ Your Engineering Department estimates that HRI will need a new manufacturing plant. This plant will be built and made ready for production this year (2022), if the decision to start the new business line is made. The plant needs a land, and you have an option to purchase a suitable land for $2,500,000. The building, which falls into the MACRS 39-year class, will cost $10,500,000. The plant will begin operating as of January 1st , 2023.
➢ The manufacturing equipment will be installed when the building is complete. The equipment falls into the MACRS 7-year class and will have a cost of $18,500,000 including transportation. Another $500,000 will also be paid for installation.
➢ HRI spent $8,000,000 on R&D for the household robot project, which has been capitalized and will be amortized over the life of the project. (Note: Amortization is the practice of spreading an intangible asset's cost over that asset's useful life.)
➢ The project will also need an initial investment in net working capital equal to 12% of the estimated sales in the first year. The initial working capital investment will be made when the plant is built, and equipment installed. In each following year, net working capital is estimated to increase by an amount equal to 12% of any sales increase in the coming year. For example, the increase of working capital in year 2 is expected to be 12% of the difference between the expected sales of year 3 and year 2.
➢ The project’s estimated service life is 8 years, (not counting the construction period in the base year). So, the service life will begin in 2023. At the end of the service life, the land is expected to have a salvage value of $4,500,000. The building will have a salvage value of $3,000,000 and the equipment will have a salvage value of $3,500,000.
➢ Your Production Department has estimated that variable manufacturing costs will total 65% of sales each year. Fixed overhead costs, excluding depreciation, will be $8,500,000 for the first year of operations. Fixed overhead costs (other than depreciation and amortization) and sales prices are estimated to increase with inflation. The estimated inflation rate is 5% per year over the project’s useful life.
➢ HRI’s income tax rate is 25% and MARR is 15%.
a) Develop the project cash flows over the useful life of the project. Use Excel to prepare the project cash flow worksheet.
b) Determine the equivalent net worth and internal rate of return of the project.
c) Determine the unit contribution margin over the service life of the project.
d) Determine the break-even annual unit sales over the service life of the project.
e) Suppose that the unit sale price could decrease by 12% annually over the previous year’s price due to severe market competition. But the annual inflation will affect all other costs except depreciation and amortization. Use a separate excel worksheet to evaluate this worst-case scenario. What will be your course of action? Is this project still feasible?
