Question

Khoury Home Appliances is a Family-owned midsized home appliance retailer located in Beirut, Lebanon. When it was founded over 30 years ago, the company originally repaired radios and other household appliances. You, as a recent MS graduate, have been hired by the company’s finance department. One of the most popular items they assemble and sell is the Smart Refrigerators. Khoury Home Appliances currently has one model on the market, and sales have been excellent. The fridge is a unique item in that it comes in a variety of tropical colors and is preprogrammed to weather changes updates. However, as with any electronic item, technology changes rapidly, and the current refrigerator has limited features in comparison with newer models. Khoury Home Appliances spent $250,000 to research about a new refrigerator that has all the features of the existing fridge but adds new features such as content search capability. The company has spent a further $200,000 for a marketing study to determine the expected sales figures for the new TV. Khoury Home Appliances can get the new fridges for $765 each in variable costs. Fixed costs for the operation are estimated to run $700,000 per year. The estimated sales volume is 4,000, 5,000, 7,500, 10,500, and 8,000 per each year for the next five years, respectively. The unit price of the new fridges will be $1,060. The necessary equipment to assemble can be purchased for $1.5 million and will be depreciated on a seven-year MACRS schedule. It is believed the value of the equipment in five years will be $385,000. As previously stated, Khoury Home Appliances currently assembles and sells a fridge. Sales of the existing model is expected to be terminated in two years. If Khoury Home Appliances does not introduce the new fridge, sales will be 8,000 units and 6,000 units for the next two years, respectively. The price of the existing fridge is $790 per unit, with variable costs of $420 each and fixed costs of $1,800,000 per year. If Khoury Home Appliances does introduce the new TV, sales of the existing fridge will fall by 1,500 units per year, and the price of the existing units will have to be lowered to $495 each. Net working capital for the fridges will be 20 percent 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. Khoury Home Appliances has a 35 percent corporate tax rate and a 12 percent required return.

​​​​​​​Required: What is the payback period of the project? 2. What is the IRR of the project? 3. What is the NPV of the project?

Answer 1

The evaluation of a new fridge project for Khoury Home Appliances requires calculating the payback period, IRR, and NPV to determine the financial feasibility.

Step-by-step explanation:

The evaluation of the new fridge project involves analyzing its payback period, internal rate of return (IRR), and net present value (NPV). Calculating the payback period involves determining how long it takes for initial project costs to be recovered through incoming cash flows. The payback period is simplistic as it ignores the time value of money and cash flows beyond the payback period.

The IRR is the rate at which the present value of future cash flows equals the initial investment, and is useful for comparing to the required return. If the IRR exceeds the company's hurdle rate, it may be considered an acceptable investment. Finally, the NPV calculation involves discounting all expected future cash flows back to present value terms at the company's required return rate. A positive NPV indicates the project adds value to the company.

To answer specific numbers for payback period, IRR, and NPV, detailed calculations using provided data are required. These calculations should account for costs of production, including materials, energy, and potential pollution control costs, which can alter production costs and impact all three financial metrics being evaluated. A comprehensive financial model that inputs all variables, including equipment costs, savings in production, research expenses, and increases in net working capital, is necessary to obtain accurate results.