Corporation developed a new product that it believes will have broad market appeal. The company’s recent cost and
marketing studies revealed the following:
a. New equipment costing $360,000 would need to be acquired to produce the product. The equipment is estimated to have a six-year useful life, with no salvage value at the end of the six years.
b. Sales in units over the next six years are projected as follows:
Year 1-20,000
Year 2-30,000
Year 3-50,000
Years 4-6 – 60,000
Production and sales of the new product would require working capital of $450,000 to finance accounts receivable, inventory, and day-to-day cash needs. This working capital would be released at the end of the project’s life.
c. The product would sell for $35 each; variable costs for production, administration, and sales would be $22 per unit.
d. Fixed costs would total $240,000 per year. These fixed costs are for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the new equipment (see item a. above). Note that the annual depreciation on the new equipment referenced in item a. above is on a straight-line basis over the six-year life.
e. To gain rapid entry into the market, the company would need to advertise heavily. The advertising program would be:
Year 1-2 – $200,000
Year 3 – $180,000
Years 4-6 – $120,000
f. The company’s required rate of return is 20%. Ignore taxes.
Please show how came to this answer
1. Determine the net present value of the investment, construct a schedule that shows the calculation of cash flows for the current year and for years 1 through 6. Then, calculate the NPV assuming a discount factor of 20%. Ignore taxes.
2. Would recommend that John Corporation accept the new product in its product line? Why or why not?
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