Reference no: EM132276100

Project - Project Cash Flows

You continue to be employed by the firm Financial Engineers Corp., which specializes in giving financial advice to both individuals and corporations. A corporate client, FitTech, has asked for advice about a new fitness watch that it plans to begin manufacturing and selling.

FitTech plans to manufacture a new fitness watch. It plans to sell the watch for a price of $150. It will sell the watches for 6 consecutive years. The projected costs of manufacturing 15,000 watches in a single year are given in Table 1.

Table 1: Annual costs to manufacture 15,000 watches

Direct materials (variable)	$400,000
Direct labor (variable)	$450,000
Manufacturing overhead
Variable portion	$100,000
Fixed portion	$90,000
Selling and administrative costs
Variable portion	$250,000
Fixed portion	$100,000

The above costs should be considered as expenses beginning in year 1. In addition to these costs, FitTech will purchase new machining equipment at a cost of $500,000 in year 0. This equipment will be depreciated for tax purposes according to the 7-years MACRS schedule. At the end of 6 years, the equipment will have a salvage value of $40,000.

FitTech will borrow $300,000 in order to finance this equipment. It will borrow the amount at 8% interest and repay the loan in 4 annual installments.

FitTech's MARR is 18%, and its tax rate is 21%.

FitTech also needs to decide whether to deliver the watches itself or hire a third-party logistics provider to deliver and transport the watches. The following explains the additional costs for each option.

Option 1: If FitTech delivers the watches itself, it will purchase 5 trucks in year 0 at a cost of $80,000 per truck. These trucks will be depreciated according to the 5-year MACRS schedule. At the end of 6 years, each truck can be salvaged for $15,000 per truck. Beginning in year 1, FitTech will also pay $110,000 per truck in each of the 6 years for operations and maintenance and labor. Option 1 also requires FitTech to invest $65,000 in a working capital fund, which will be fully recoverable at the end of 6 years.

Option 2: If FitTech hires a third-party logistics provider, it will pay an annual fixed cost of $450,000 plus $15 for every watch that it produces, beginning in year 1. These annual fixed and variable costs are in addition to those listed above. FitTech will not need to purchase any trucks or invest in a working capital fund if it selects option 2.

FitTech is asking for advice on three basic questions:

1. If FitTech sells 15,000 watches in each year for 6 years, what is the net cash flow for each option? Based on a net present worth analysis, should FitTech choose option 1 or option 2?

2. FitTech executives are concerned that the company may not be able to sell 15,000 watches in each year. Assume that FitTech will sell an identical number of watches in each of the 6 years. What is the fewest number of watches that FitTech could sell each year that would still make selling the fitness watch a good decision?

3. The marketing team at FitTech believes that FitTech may actually sell more than 15,000 watches each year. Assume FitTech will sell an identical number of watches in each year. What is the minimum number of watches that FitTech would need to sell in each year to incentivize it to switch from one option to the other option?

Deliverable -

You should calculate the project cash flows for each option and use the project cash flows to answer the three questions above. You should use the Excel template provided on Canvas to calculate a separate income statement and cash flow statement for each option. For both options, it is easiest to link the number of watches to an identical cell in order to answer questions 2 and 3.

You should write a professional memorandum (memo) advising FitTech on whether it should choose option 1 or 2, the fewest watches that would still make selling a watch a good decision, and the minimum number of watches at which FitTech would switch from one option to the other option. See the attached Word document "Writing a professional memo.docx" for expectations and guidelines on writing a professional memo.

You should upload your memo via Canvas. Only one person per group (maximum 3 people) needs to upload the memo, but make sure that each person's name in your group is on the memo. Your grade will be docked by 10 points for each day that you submit the memo after the due date.

The memo should contain 4-5 paragraphs. The first paragraph should be an executive summary that summarizes your analysis and provides your final recommendation. One paragraph should discuss the project cash flows and net present value for option 1 with 15,000 watches per year. The third paragraph should discuss the project cash flows and net present value for option 2 with 15,000 watches per year. You should not go into details about the calculations in the memo, but you should explain briefly why the project cash flow has those numbers. Using a table to depict the project cash flows is a good idea.

The final one or two paragraphs should briefly compare the two options and explain which option you recommend. Be sure to explain on what basis you are making your recommendation. You should try to provide some intuition for why that option is the best. You should also answer questions 2 and 3 for FitTech. A column or bar graph showing the cash flows for the different options could be a helpful way to compare and contrast the two options.

Finally, please copy and paste the Excel worksheets as an appendix to the memo. This is the one time that it is acceptable to copy and paste from Excel into the Word document. For other tables within the body of the memo, you should work on creating professional-looking tables as described in "Writing a professional memo.docx." The Excel worksheets should be pasted as a picture in the Word document. The copied Excel worksheets should be based on 15,000 watches per year. You can reference these appendices in the body of the memo. See the end of this document for an example of how the Excel worksheet should be pasted into the appendix.

Attachment:- Assignment Files.rar