Description
Individual Assignment: Case Study (20%)
FIN537: Corporate Finance
Semester March- July 2025
Submission date: Week 10 – 13 June 2025
Minicase:
Kobo Electronics is a mid-sized manufacturer headquartered in Canada and owned by a Japanese company. When it was founded over 20 years ago, the company initially repaired radios and other household appliances. Over the years, the company expanded into manufacturing and is now a reputable manufacturer of various electronic items. One of the major revenue-producing items manufactured by this company is a notebook. This company currently has one notebook model on the market, and sales have been excellent. The notebook is a unique item in that it comes in a variety of pastel colours and is programmed to stream videos, play games, and read e-books on a larger screen than a smartphone. However, as with any electronic item, technology changes rapidly, and the current notebook has limited features compared to newer models. Previously, Kobo Electronics spent $850,000 to develop a prototype for a new smart notebook that has all the features of the existing notebook but adds new features such as smartphone capability with AI tools. The company has spent a further $350,000 on a marketing study and consultation fee to determine the expected sales figures for a new smart notebook.
Kobo Electronics can manufacture the new smartbook for $155 each with variable costs. Fixed costs for the operation are estimated to run $4.5 million per year. The estimated sales volume is 74,000, 95,000, 125,000, 105,000, and 80,000 per year for the next five years, respectively. The unit price of the new smart notebook will be $590.The necessary and associated equipment for this new product can be purchased for $20 million and will be depreciated over five years using the straight-line method. It is believed that the value of the equipment in five years will be $4.1 million.
As previously stated, Kobo Electronics currently manufactures notebooks. Production of the existing model is expected to be terminated in two years. If Kobo Electronics does introduce the new model of notebook, sales of existing notebooks will fall by 15,000 units per year, and the price of existing units will have to be lowered to $255 each. Net working capital (NWC) for the notebooks will be 20% 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 year’s sales. Kobo Electronics has a 35% corporate tax and a 12% required return (incorporated with inflation).
However, Kobo Electronics is not confident about its sales volume and selling price estimates. The company assumed that the expected sales volume is an average of 100,000 per year for five years. In the worst case, unit sales and unit prices may decline by 20%. On the other hand, unit sales and unit prices may increase by 20% under the best-case scenario. Another view of analysis is to look at all variables involved with certain upper and lower bounds for each. Note that the upper and lower bounds vary by 20% from the base figure, which represents the expectation of the degree of the variation for each variable. Furthermore, the company also measures the Net Present Value (NPV) for a given change in unit sales, unit price, variable cost, and fixed cost, respectively. The company assumes that each variable will increase by 20%. Based on this analysis, the company identified that, given the four variables, the NPV are most sensitive to the change in unit prices and variable costs.
In the following analysis, Kobo Electronics continued focusing on several measures of sufficient sales volume to provide a comprehensive overview of the subject matter and the importance of financial planning and capital budgeting decisions. This analysis is helpful in assessing the margin of safety for a given level of sales. Referring to the average sales volume above, the unit sales level has already met the break-even point level, with the degree of operating leverage (DOL) at a low level, 1.17 times. In the meantime, to avoid calculating NPV in downwardly biased terms, Kobo Electronics also considered the inflation premium in the cash flows, and the cash flows are stated in current dollars. Meanwhile, the capital ceiling cannot be exceeded by $18 million due to the capital constraint faced by Kobo Electronics. Thus, caution is the key for Kobo Electronics when making project analysis and evaluation, as it may mislead decision-making.
Questions:
- What are some irrelevant and relevant incremental cash flows of this new project of Kobo Electronics? Construct relevant cash flows and calculate the NPV.
- Does Kobo Electronics conduct the essential analysis? Why? Explain and calculate each of these analyses.
- In the context of capital rationing, the implication is that Kobo Electronics generally face what problem? Provide suggestions for Kobo Electronics.
REMINDER: Please remember that this assignment will use Turnitin as a plagiarism detection tool. I have no tolerance for plagiarism, and students who are not accountable for their work can significantly impact their marks.
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