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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,

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:

Year Sales in Units

1. 4,000

2. 7,000

3. 10,000

4-12 12,000

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:

Amount of Yearly

Year Advertising

1-2. $70,000

3 $50,000

4-12.. $40,000

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 companys 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?

Most of the responses I've seen do not show where income tax is taken into consideration

Our professor gave us the below hint:

  1. 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:
Year 0Net Asset Acquisition Old Asset Retirement Comission and Fees Expenditures Salvage Value Pretax Net Cash Inflow (Outflow) Depreciation Taxable Income (net cash flow-dep) Income Tax Payable (taxable income*.20) Net Cash Inflow (Outflow) (pretax net cash flow-income tax payable)- Present Value Factor at 20 Percent1.0000 Present Value of Cash Flows- Net Present Value

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