Question
Diana's friend, using her marketing knowledge has recently undertaken, at the cost of $3,000, a detailed analysis of the emerging trends in the furniture industry,
Diana's friend, using her marketing knowledge has recently undertaken, at the cost of $3,000,
a detailed analysis of the emerging trends in the furniture industry, Based on the findings, she
supperted that, to remain competitive, the business must add at least one new type of
furruture to its existing product mix. Working together with Diana, who has some accounting
and finance knowledge, she has come up with two propositions, the Cora and the Dona, which
are new design wooden center tables. Due to limited funds, Diana must act only one
project
The Cora is expected to be produced and sold in monthly batches of 5,000 units. Selling price
is expected to be 512 in the first 2 years, rising by 5% each year in the following 3 years.
Variable production costs would amount to 58 per unit and this is expected to rise by 3%
annually over the next 5 years. A special wood cutting machine will have to be bought
immediately, costing $900,000 and scrap value is expected to be $50,000 at the end of its
Hetime.
The Dona will require investment in a new machine costing $500,000, scrap value being $
25,000. Monthly production is expected to be 4,000 units. Since it will be using better wood
quality, variable costs are expected to be $10 per unit, rising by 5% each year. Selling price
would be 513 and this is expected to remain constant.
Both projects would necessitate additional working capital of 550,000 immediately, which will
be recovered in full at the end of the project's life.
Diana is of the view that since Dona requires lower investment and has a higher selling price,
it will be more profitable to invest in this project.
Required: Advise Diana which project is the better investment, supporting your answer
with relevant calculations.
(10 marks) ( also use profitability index if possible)
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