Phoenix Engineering, Inc. manufactures electronice components for the automotive and computer industries, as well as producing a variety of small electronic appliances that are distributed through wholesalers. The company's R&D Department has developed an electronic device that management believes could be modified and marketed as an electronic game.

The following information for the new product was developed from the best estimates for the marketing and production managers:

Annual Sales Volume: 1,000,000 units

Selling Price: $10 per unit

Cash Variable Cost: $4 per unit

Cash Fixed Price: $2,000,000 per year

Investment Required: $12,000,000

Project Life: 5 Years

At the end of the five-year usefull life, there will be a zero terminal disposal price.

Phoenix Engineering use discounted cash flows analysis in its decision making. Its required rate of return is 14% percent.

The toy and games industry is a new market for the firm, and management is concerned about the reliability of the estimates. The controller has proposed applying sensitivity analysis to selected factors, and is investigating some alternatives. Ignore income taxes in your computations.

Required:

1. What is the NPV of this investment?

2. What is the effect on the net present value of the following three changes in assumptions?

(Treat each item independently of the others)

(a) a 10% reduction in the selling price,

(b) a 10% reduction in annual sales in units),

(c) a 10% increase in the variable cost per unit.

3. Discuss how management would use the data developed in requirements 1 and 2 in its consideration of the proposed capital investment.