Mini Case Study: Looking Sharp Clothing, Inc.

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The Look Sharp Clothing, Inc. currently sells customized, tailored-to-fit suits. Currently, it sells 1,200 suits annually at an average price of $1,335 each. The owner is now considering adding a lower-priced line of suits, which will attract younger professionals, that sell for $250 each. The firm has spent $80,000 for a marketing study to determine the expected sales for the new line. The results show that it can sell 1,652 units of the lower-priced suits per year for the next three years but will sell 200 units less of the higher-priced, customized suits by doing so.

The new lower-priced line will initially require $90,000 investment in a new sewing machine that will be depreciated straight-line to a zero over the 3-year life of the project. It is believed that the sewing machine can be salvaged at $7,000 at the end of the project. The new sewing machine will also require annual maintenance which will cost $2,000 per year to the firm. The project requires an initial investment in net working capital of $10,000, all of which will be recovered at the end of the project. The owner has decided to finance this project with a 3-year loan at 6 percent annual interest rate.

The firm can manufacture the new line suits for $72 each in variable cost while the fixed costs are estimated to be $68,000 per year. The existing customizable suits are manufactured with variable costs of $100 per unit and fixed costs of $150,000 per year. The firm has a 35 percent corporate tax rate and requires 15 percent return on this project. Calculate the NPV, the Profitability Index, the IRR, and the payback period of this project. (20 points)

*Please note that the preparation of proforma income statement, the construction of cash outlay, and the calculation of NPV, PI, IRR, and the payback period will be graded separately. Therefore, a mistake at the beginning will not result with all points being taken off.

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