How would you interpret the profitability index

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Reference no: EM131934062

J. Smythe, Inc., manufactures fine furniture. The com¬pany is deciding whether to introduce a new mahogany dining room table set. The set will sell for RM25,000, including a set of eight chairs. The company feels that global sales of the set will be 1,800, 1,950, 2,500, 2,350, and 2,100 sets per year for the next five years, respectively. Variable costs will amount to 45 percent of sales, and fixed costs are RM8.5 million per year. The new tables will require inventory amounting to 10 percent of sales, pro¬duced and stockpiled in the year prior to sales. It is believed that the addition of the new table will cause a loss of 250 tables per year of the oak tables the company pro¬duces. These tables sell for RM20,000 and have variable costs of 40 percent of sales. The inventory for this oak table is also 10 percent of sales. J. Smythe currently has excess production capacity. If the company buys the necessary equipment today, it will cost RM72 million. However, the excess production capacity means the company can pro¬duce the new table without buying the new equipment. The company controller has said that the current excess capacity will end in two years with current production. This means that if the company uses the current excess capacity for the new table, it will be forced to spend the RM72million in two years to accommodate the increased sales of its current products. In five years, the new equipment will have a market value of RM14 million if purchased today, and RM33 million if purchased in two years. The equipment is depreciated on a seven-year MACRS schedule. The company has a tax rate of 40 percent, and the required return for the project is 14 percent.

1. Should J. Smythe undertake the new project?

2. Can you perform an IRR analysis on this project? How many IRRs would you expect to find?

3. How would you interpret the profitability index?

Reference no: EM131934062

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