Reference no: EM132722925

Question - A company has is planning to introduce a new product to its existing line. Annual sales are estimated to be 5000 units at a price of $69 per unit. Variable manufacturing costs are expected to be $39 per unit. Incremental fixed manufacturing costs (other than depreciation) are expected to be $30000 and incremental selling expenses to be $35,000 annually.

To build the new product the company must invest $200,000 in special equipment with a change in design every 5 years (no salvage value). Straight line depreciation. Company Tax 30%. All revenue will be paid in cash.

A) Calculate the annual implications after tax.

B) Calculate the annual cash flow consequences over the life of the first model.

C) Calculate:

1) ARR

2) Payback

3) NPV (15% discount value)

Over the past 2 years the company has invested $5m in R&D. The product is now ready to sell. Which option should they consider (mutually exclusive).

Option 1. Manufacture the product itself

The company has manufacturing space it presently rents out for $100,000 annually.

Purchase Plant and Equipment $9m with a $1m residual after its 5 year life span.

It will also need $1m of working capital from the beginning of year 2.

Market research which costed $50,000 has indicated the following sales figures:

2020: 800,000

2021: 1,400,000

2022: 1,800,000

2023: 1,200,000

2024: 500,000

Selling price per unit:

Y1: $30

Y2: $22

Y3: $22

Y4: $22

Y5: $16

Y6: $16

Variable Costs Per Unit: $16

Rates and taxes (not including income tax) $65,000

Wages and Salaries (fixed) $900,000

Advertising linked to sales: $1,300,000

Initial Promotion & marketing: $700,000

Office Costs $200,000

Other fixed expenses $380,000

Cost of Capital: 5%

OPTION 2. Another company can carry out the manufacturing and marketing under a license. The company has offered to carry out the manufacturing and marketing and will a royalty fee of $5 per unit to do so.

It has been estimated that the sales will be 10% higher than in option 1.