Question
A new pair of blue jeans has been created by a company. Marketing research, which cost $100,000, projects that 31,000 of these red jeans will
A new pair of blue jeans has been created by a company. Marketing research, which cost $100,000, projects that 31,000 of these red jeans will sell for $97. The variable cost is $15. However, the blue jeans will cut into the sales of the yellow jeans. Sales for the yellow jeans will decline by 17,000. They sold for $150 and had a variable cost of $35. Annual rent and utilities are expected be a total of $50,000. The property, plant, and equipment necessary for production is $2,000,000. The salvage rate is 15% (gross of taxes) at the end of the life of the product. Remember that when you sell the PPE, it will have no cost basis since you depreciated it throughout the 5 years. Net working capital will be needed of $100,000 to start and then will need a further $10,000 increase every year of production. All of the net working capital can be salvaged with no tax impact. The jeans are expected to sell for 5 years, and then preference will switch to brown jeans (i.e. life of product is 5 years). Your company has a tax rate of 21% and a WACC of 9%. In the base-case scenario, should you launch this product if you use NPV as your decision criteria?
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