DCF, sensitivity analysis, no income taxes. (CMA adapted) Bristol Engineering Inc.

manufactures electronic components for the automotive and computer industries and produces a variety of small electronic appliances that are distributed through whole¬

salers. The company’s Research and Development Department has developed an electronic device that management believes could be modified and marketed as an electronic game.

The following information for the new product was developed from the best estimates of the marketing and production managers.

Annual sales volume Selling price Cash variable costs Cash fixed costs Investment required Project life 1,000,000 units

$12 per unit

$4.80 per unit

$2,400,000 per year

$14,400,000 5 years At the end of the five-year useful life there will be a zero terminal disposal price.

Bristol Engineering uses discounted cash-flow analysis in its decision making. Its required rate ofreturn on this project is 14%.

The toy and game industry is a new market for Bristol Engineering, and management is concerned about the reliability of the estimates. The controller has proposed applying sensi¬

tivity analysis to selected factors, and is investigating some alternatives. Ignore income taxes in your calculations.

Required 1. What is the net present value ofthis investment proposal?

2. What is the effect on the net present value ofthe following three changes in assumptions?

Treat each item independently ofthe others.

a. 10% reduction in the selling price.

b. 10% reduction in annual sales in units.

c. 10% reduction in the variable cost per unit.

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3. Discuss how management would use the data developed in requirements 1 and 2 in its consideration ofthe proposed capital investment.