Chapter 8 Case Hint To help make sure you get off to a good start on the Chapter 8 Case, here is a hint: The case may be approached in two ways: 1. Treat Req. 1 and Req. 2 independently. For Req. 1 Calculate the yearly cash flows (including tax effects) from only the sales of smoke detectors. For Req. 2 Determine the present values of your results from Req. 1 and combine those present values with the present values of the remaining cash flow items in the case to determine NPV. 2. Treat Req. 1 and Req. 2 together as a part of a "big picture" approach. To do this, construct a spreadsheet similar to Exhibit 8.2 on page 276 which incorporates all the cash flow items mentioned in the case. This is the approach I would recommend. Englewood Company has an opportunity to produce and sell a revolutionary new smoke detector for homes. To determine whether this would be a profitable venture, the company has gathered the following data on probable costs and market potential: a. New equipment would have to be acquired to produce the smoke detector. The equipment would cost $100,000 and be useable for 12 years. After 12 years, it would have a salvage value equal to 10% of the original cost. b. Production and sales of the smoke detector would require a working capital investment of $40,000 to finance accounts receivable, inventories, and day-to-day cash needs. This working capital would be released for use elsewhere after 12 years. c. An extensive marketing study projects sales in units over the next 12 years as follows: d. The smoke detectors would sell for $45 each; variable costs for production, administration, and sales would be $25 per unit. e. To gain entry into the market, the company would have to advertise heavily in the early years of sales. The advertising program follows: f. Other fixed costs for salaries, insurance, maintenance, and straight-line depreciation on equipment would total $127,500 per year. (Depreciation is based on cost less salvage value.) g. The company's required rate of return and tax rate are both 20%. Required: 1. (6 points) Compute the net cash inflow (cash receipts less yearly cash operating expenses) anticipated from the sale of the smoke detectors for each year over the next 12 years. 2. (4 points) Using the data computed in (1) above and other data provided in the problem, determine the net present value of the proposed investment. Would you recommend that Englewood Company accept the smoke detector as a new product
