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Mini-Case BioCom, Inc.: Part 2, Evaluating a New Product Line Thambre in MyFinanceLab Ilocom, Inc. is weighing a proposal to manufacture and market a fiber optic device that will continuously Projected annual rate of sales monitor blood pressure during cardiovascular surpery increases 6% and other medical procedures in which precise, real-time Coat of goods sold 40% of sales measurements are critical The device will continuously transmit information to a computer via a thin fiber optie Selling general, and administra: cable and display measurements on several large mont tive expenses 5% of sales sors in view of operating room personnel. It will also wore Annual fixed cost $300.000 the data and display it graphically for review during or atter procedures. Biocom would market various versions Operating cash flow from current of the device, but manufacture all of them in the same desk sales $1,550,000 facility using the same equipment. They would have simi Economic life of the project 5 years lar markups and cost structures. If management decides to bring this device to market. BioCom will stop selling Initial change in networking an earlier, less sophisticated version of the monitor. The capital 5480,000 product that BioCom will discontinue now contributes Depreciation 5-year MACRS bout $1,650,000 per year to operating cash flow, and Tax rate 349 projected sales are flat. BioCom focuses exclusively on cutting-edge applications, so it expects to discontinue the Discount rate cost of capital 9% new monitor after five years. At that time, it will sell the technology and used manufacturing equipment to a for Questions eign company for an estimated $2,400,000 1. What is the total relevant initial investment for Cost analysts have collected the following figures BioComis new product line? Would you include and submitted them to the treasurer's office for addi- the designs and prototypes? Would you include the tional study and a final decision on whether to proceed. change in net working capital? You, as assistant to the treasurer, must compute and evaluate the basic capital budgeting criteria. The proj- 2. What is the cash flow resulting from disposal of the ect will initially increase working capital by $480,000. equipment at the end of the project? which the company will recover at the end of the project 3. Compute a schedule of depreciation for the plant when it sells remaining inventory and collects accounts and equipment receivable. The analysts are not quite sure if they should 4. Compute a schedule of operating cash flows for include $450,000 that the company already spent on re- BioCom's new product. search and development for the new product. They also 5. Compute a schedule of incremental cash flows for disagree about whether the effect of the discontinued BioCom's new product monitor on the company's overall operating cash flows is relevant to the decision on the new product line, so 6. Compute the project's net present value. you must decide how to deal with these two items. 7. Does your answer to Question 6 indicate that man- agement should accept or reject the product? Cost of new plant and equipment $24,000,000 8. Challenge question. Use a spreadsheet for this question Designs and prototypes s 450,000 a. Recompute your answers to Questions 4 through Estimated salvage value of tech- 7 assuming that sales grow at 12% per year. nology and equipment, end of $ 2,400,000 b. Recompute your answers to Questions 4 through year 5 7 assuming that sales grow at 0% per year. First-year sales forecast Comment on the sensitivity of the NPV to the $16,500,000 growth rate of sales. C c. Comment on the sensitivity of the NPV to the growth rate of sales