ComCo makes wireless routers and other network communication products. Since its inception in the early 1990s, ComCo has successfully implemented a strategy of investing heavily in product development and introducing a new model with more enhanced features every three to four years. Every time a new model of a product is introduced, the old model is slowly phased out by first cutting prices on the old model to push as much of the inventory out as possible, and then abandoning the model.

In January, 2008 ComCo introduced the next generation of wireless broadband routers, C200H, and quickly abandoned the previous model. The following table presents the initial outlays and cash flow estimates for the next four years for C200H, based on which the CEO of ComSys, Martha Kline, gave a green light to introducing the product.

Initial cash outlay ......... $9,000,000

Net cash inflows—year 1 ...... $5,000,000

Net cash inflows—year 2 ...... $6,500,000

Net cash inflows—year 3 ...... $4,000,000

Net cash inflows—year 4 ...... $1,000,000

Salvage value (at the end of year 5) ...... 0

The company expects 14% rate of return on all its projects. The corporate tax rate is 30%. In August, 2008, Lara Garcia, one of the product development engineers, burst into Martha’s office all excited. Her product development team had just successfully tested a new and much improved router. This was truly an innovative product. It did not take long for Martha to realize that she had a jewel in her hand. Her senior associates agreed. The new product, C300G, had the potential of propelling the company leaps and bounds ahead of the competition.

Soon, however, an unsettling calm set in as the management team tried to get a handle on the decision they were facing. They came up with a list of issues to take into account and address:

• The new router, C300G, could be introduced as early as January 2009. However, it would require a separate production facility from the existing facility used for making C200H.

• Introduction of C300G in January 2009 would mean that the existing router, which was beginning to do well in the market, would lose some of its market because most customers would prefer C300G over C200H.

• It was only a matter of time before other competitors came up with a technology comparable to C300G. The team estimated that they had about a year’s head start on this new technology. So, while delaying the introduction of C300G to the following year could help sell the existing product (C200H) and recoup some of the investment in that product, it could cost the company some market share in C300G (the company would lose the timing advantage).

Members of the management team were split in their opinions on what was the right course of action, and decided to prepare a report providing a financial comparison of two options:

1. Introduce C300G on January 1, 2009, and phase out C200H over the next three years.

2. Introduce C300G on January 1, 2010, and phase out C200H over the next two years. Under both options, the company will continue to produce as much of C200H as it can sell over the remaining years. The management team performed a careful analysis and presented a report to Martha with their recommendations. The following two tables present the financial estimates corresponding to the two options:

Required:
a. What should Martha do? Assume that all equipment is depreciated over four years, using the straight-line method.
b. What are some of the qualitative considerations that Martha and her management team should take intoaccount?

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C200H Option 1 (introduce C300G İnlen 2009) Cash outlay to introduce G300G Net cash inflows-2009 Net cash inflows-2010 Net cash inflows-2011 Net cash inflowS-2012 Salvage value at the end of 2012) Option 2 (introduce C30()G İn 1 /2010) Net cash inflows-2009 Cash outlay to introduce C300G C300C $15,000,000 $10,000,000 20,000 $850,000 $250,000 $6,000,000 4,000,000 $2,000,000 0 C300C C200H $6,500,00 $15,000,000 at the end of 2009 Net cash inflowS2010 Net cash inflows-2011 Net cash inflows-2012 Net cash inflows-2018 Salvage value (at the end of 2013) $6,000,000 $4,500,000 $2,000,000 $1,000,000 $500,000 $150,000