Reference no: EM132596591
Frame Inc. is a manufacturer of aluminum windows and shades. For the past few years the firm had spent $ 200 million on the development of a new technology-transparent shade, which according to the firm will be a huge success.
According to the firm, this technology is an intermediate technology. The firm is working on an innovative shade-the inexistent shade which will replace the transparent shades in 6 years.
Lately, Frame discovered a significant problem in the manufacturing process of the new shades.
According to the firm, manufacturing problem can be fixed today at a cost of $ 10 million. Immdiately after the problem is fixed, the firm will start manufacturing the transparent shades. In order to manufacture the shades, the firm will need to invest $ 240 million in new equipment.The investment will be depreciated over 8 years with no salvage value in the end. The firm expects that it will be able to sell the equipment after 6 years for $ 20 million.
The firm expects revenues to be $ 85 million in the first year.These revenues will grow by 15 % every year until the termination of the project (in 6 years-when the new inexistent shades will enter the market).
The operating costs are to be 40 % of revenues.
The firm expects that due to the introduction of the transparent shade the annual opearting revenues from its other sales will decrease by $ 5 million in the first 3 years of production and then after by $ 2 million for each of the 3 following years.
The firm estimates that the project will require working Capital at the beginning of each production year which will be recovered at the end of the project. The estimated working capital is 20 % of the revenues.
Assume that the corporate tax rate is 25 %, capital gain tax is 20 % and that the opportunity cost of capital is 11 %. Also, unless stated otherwise, all cash flows occur at the end of each year.
Due to estimated fixing costs of this problem, the development costs spent on the prject and the fact that in 6 years the firm will have an innovative technology, which will replace the transparent shades, the firm is considering cancelling the project.
Should Frame fix the problem and continue the project or should the firm cancel it?