Question
J. Smythe, Inc. manufacturers fine furniture. The company is deciding to introduce mahogany dining room table set. The set will sell for $6100, including a
J. Smythe, Inc. manufacturers fine furniture. The company is deciding to introduce mahogany dining room table set. The set will sell for $6100, including a set of 8 chairs. The company feels that sales will be $1800, $1950, $2500, $2350, and $2100 sets per year for the next five years. Variable costs will amount to 45% of sales and fixed costs are $1.9 million per year. The new tables will require inventory amounting to 10% of sales, produced and stock piled in the year prior to sales. It is believed that the addition of the new table will cause a loss of 250 tables per year of the oak tables the company produces. These tables will sell for $4500 and have variable cost of 40% of sales. The inventory for this oak table is also 10% of sales. J. Smythe currently has excess production capacity. If the company buys the necessary equipment today, it will cost $18 million. However the excess production capacity means the company can produce the new table without buying the new equipment. The company controller has said that the current excess capacity will end in two years with current production. This means that if the company uses the current excess capacity for new table, it will be forced to spend $18 million in two years to accommodate the increased sales of it's current products. In 5 years the new equipment will have market value of $3.1 million if purchased today, and $7.4 million if purchased in two years. The equipment is depreciated on a seven year MACRS schedule. Company has tax rate of 40% and required return for the project of 11%.
A) Should the company undertake new project?
B) Can you perform IRR analysis on projects? Or how many IRR's would you expect to find?
C) How would you interpret the profitability index?
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