NPV Problem

Furniture for the Future, Ltd (FFF) is a company that makes furniture out of specific branches of native Australian trees that are quick to regrow and are high in carbon uptake, making it eligible for the unique carbon-negative label.

The company is considering a new line of furniture: sofa beds. Undertaking this new line would require a new specialized wood-cutting machine and 4 small 3D printers for the printing of parts. FFF wants to remain competitive and therefore expects that if the product sells well, they will want to produce an upgraded version of the sofa bed in 5 years and cease production of the original model.

You have worked for FFF for a year now and your manager has asked you to help analyse the potential new product. Your team has collected the following estimations and grouped them into four areas: Revenue, Costs, Wood-cutting machine and 3D printers.

1. Revenue & costs

• FFF conducted market research (costing $10,000) showing that annual sales are expected to be around 700 sofa beds per year for 5 years.

• Each sofa bed will be sold for $900.

• If the new Sofa bed is launched, FFF projects that net revenue from their existing SideTable line will increase

  by $5,000 per year.

• Variable costs of production are $150 per bed for the projected 700 beds sold per year.

• Fixed costs of production are $60,000 per year.

• Administrative costs will increase by $2,000 per year because of the new product line.

• If FFF launches the sofa bed, they will increase their box order with CustomBoxCo, reducing their per-unit

  box cost on other product lines. This is estimated to save $2,000 per year.

• The company will produce its product in its current workplace, which it rents for $6,000 per year.

2. Capital Expenditures

• The new wood cutting machine will cost $420,000.

• ATO regulations require depreciation over 10 years to zero using the straight-line method.

• At the end of 5 years, the estimated value of the wood cutting machine is $50,000.

• The total cost of the required 3D printers is $750,000.

• ATO regulations require depreciation over 15 years to zero using the straight-line method.

• At the end of 5 years, the estimated value of the 3D printers is $300,000.

  Additional Information

• The project will require working capital of $15,000 which will be recovered at the end of the 5-year life of the project.

• FFF faces a corporate tax rate of 30%.

• FFF estimates the cost of capital for this project at 17%.

• FFFs policy is to reject projects with a payback period of more than 3 years.

• When FFF estimated the distribution of the key inputs, they estimated the 25th, 50th, and 75th percentile of

the probable outcomes:

That is, there is a 25% probability that sales will be below 450 units per year, a 50% probability that sales will be below 700 units per year and a 75% probability that sales will be below 950 units per year. The other table rows can be interpreted in a similar manner.

These estimated probability distributions could be greatly narrowed with further market research, which would cost $2,000 per variable.

In your discussion groups, work on performing whatever analysis you believe is necessary to determine which variable(s) would warrant this further investment in market research.

Q1. Tax Rate?

Q2: Rate of Return?

Q3: The annual cash flow to use for revenue is?

Q4: The annual cash flow for operating expenses is?

Sales in Units Revenue per unit 25th Percentile 450 $700 50th Percentile 700 $900 75th Percentile 950 $1100 Variable cost per unit Fixed costs $100 $45,000 $150 $60,000 $200 $70,000 Sales in Units Revenue per unit 25th Percentile 450 $700 50th Percentile 700 $900 75th Percentile 950 $1100 Variable cost per unit Fixed costs $100 $45,000 $150 $60,000 $200 $70,000