1. Business
  2. Finance
  3. stmicroelectronics a sensor equipment manufacturer with its factory located in...

Question: stmicroelectronics a sensor equipment manufacturer with its factory located in...

Question details

STMicroelectronics a sensor equipment manufacturer with its factory located in Shenzhen, China. STMicroelectronics products obtained ISO-22301 certification. Assume that STMicroelectronics has recently developed a new model of the sensor after extensive research and development and proved that there is a significant market for the new model. The new model will be put into the market this year and is expected to stay in the market for four years.

Except for the initial investment that will occur immediately, all cash flows will occur at year-end. To make the new model, STMicroelectronics must initially invest US$150 million in production equipment. The equipment can be sold for US$50 million at the end of four years. STMicroelectronics can sell the new model to two distinct markets:

  1. Original manufacturer market—this market consists primarily of the large cell phone companies that buy sensor equipment for their phone. The new model is expected to sell for US$40 per sensor, and the variable cost of each sensor is US$25.

  1. Replacement market—this market consists of all sensor’s equipment purchased after the cell phone has left the factory. The new model in this market is expected to sell for US$50 per sensor, and the variable cost of each sensor is US$25 which is the same as that in the original manufacturer market.

The project will incur US$25 million in marketing and general administrative costs the first year, and this cost is expected to increase at the inflation rate in subsequent years. STMicroelectronics also intends to raise the selling price of the new sensor at the inflation rate. The annual inflation rate is expected to remain constant at 3,50 percent. Variable costs are expected to increase at 1 percent above the inflation rate.

Tech analysts expect cell phone manufacturers will produce 5,5 million new phones this year and production will grow at 2,5 percent per year thereafter. Each new phone needs four sensors. STMicroelectronics expects the new model will capture 10 percent of the original manufacturer market.

Analysts also estimate that the replacement market size will be 15 million sensors this year and that it will grow at 2 percent annually. STMicroelectronics expects the new model will capture 8 percent market share.

The equipment will be depreciated on the straight-line basis. The immediate initial working capital requirement is US$10 million, and the net working capital requirements will be 15 percent of sales. STMicroelectronics's effective corporate tax rate is 40 percent and its required return is 15 percent.

Instruction:

Perform the capital budgeting analysis (NPV, Payback Period, IRR and PI) to determine whether STMicroelectronics should accept or reject the project! Write briefly the necessary assumptions and estimations for your analysis!

Solution by an expert tutor
Blurred Solution
This question has been solved
Subscribe to see this solution