Reference no: EM133031577
Question - You work for a firm that specializes in office equipment. Your company predicts that more people will prefer to work from home after the pandemic compared to before and have asked you to analyze a proposal on adding to its product line a newly designed ergonomic home office chair.
You believe this product would remain popular for at least the next 8 years, after which new designs are likely needed.
The material cost for each chair is $500 in the first two years, and you estimate the cost will decrease by 15% each year in the following two years as countries re-open and suppliers come back to business. After that, the material cost will remain stable. To assemble the components, your firm would need to invest in specialized machinery that cost $1,250,000. The machinery has salvage value of about $16,000 (it could be sold for this price or used in a new standing desk project)
Note: Cost is depreciated to zero using the straight-line method irrespective of the fact that the equipment could be sold at the end of year 8. By salvage value here we simply mean the expected selling price of the equipment at the end of year 8. The fixed costs of operating the assembly line would be $450,000 in the first year, and remain at this level for the rest of the years. You project sales to be 4,500 units in the first year, growing by 20% each year in years 2 through 3, decline by 10% in year 4 as more competitors enter into the space. The sales will drop further by 500 units each year from year 5 to 8. Your firm has tentatively priced the chair at $699 each and plan to give 20% off the full price in year 7 and 8. You estimate the net working capital requirement for this project to be 3% of revenues, and changes in net working capital would need to be established ahead of the revenues (e.g., the increase in net working capital at time zero is 3% of expected revenues in Year 1, and the change in net working capital at time one is 3% of the expected change in revenues from Year 1 to Year 2). You expect to recover all net working capital at the end of year 8. The relevant tax rate for your firm is 28%.
Required -
a) What is the NPV of this project if the firm's required return is 12.4%?
b) What is the IRR of this project?
c) Should the firm add this chair to its product line?