Vernon Enterprises designs and manufactures toys. Past experience indicates that the product life cycle of a toy

Question:

Vernon Enterprises designs and manufactures toys. Past experience indicates that the product life cycle of a toy is three years. Promotional advertising produces large sales in the early years, but there is a substantial sales decline in the final year of a toy's life. Consumer demand for new toys on the market tends to fall into three classes. About 30 percent of the new toys sell well above expectations, 60 percent sell as anticipated, and 10 percent have poor consumer acceptance.

A new toy has been developed. The following sales projections were made by carefully evaluating consumer demand for the new toy: image text in transcribed

Variable costs are estimated at 30 percent of the selling price. Special machinery must be purchased at a cost of $\$ 860,000$ and will be installed in an unused portion of the factory that Vernon has been unsuccessfully trying to rent to someone for several years at $\$ 50,000$ per year; there are no prospects for future utilization. Fixed expenses (excluding depreciation) of a cash-flow nature are estimated at $\$ 50,000$ per year on the new toy. The new machinery will be depreciated by the sum-of-the-years'-digits method with an estimated salvage value of $\$ 110,000$ and will be sold at the beginning of the fourth year. Advertising and promotional expenses will be incurred uniformly and will total $\$ 100,000$ the first year, $\$ 150,000$ the second year, and $\$ 50,000$ the third year. These expenses will be deducted as incurred for income tax reporting. Vernon believes that state and federal income tax will total 60 percent of income in the foreseeable future and may be assumed to be paid uniformly over the year income is earned.
(1) Prepare a schedule computing the probable sales of this new toy in each of the three years, taking into account the probability of above average, average, and below average sales occurring.
(2) Assume that the probable sales computed in (1) are $\$ 900,000$ in the first year, $\$ 1,800,000$ in the second year, and $\$ 410,000$ in the third year. Prepare a schedule computing the probable net income for the new toy in each of the three years of its life.
(3) Prepare a schedule of net cash flows from sales of the new toy for each of the years involved and from disposition of the machinery purchased. Use the sales data given in ( 2 ).

(4) Assuming a minimum desired rate of return of 10 percent, prepare a schedule of the present value of the net cash flows calculated in (3). The following data are relevant: image text in transcribed