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Quarefel plc is considering entering the market for a single product which has an estimated life cycle of three years. The following information has
Quarefel plc is considering entering the market for a single product which has an estimated life cycle of three years. The following information has been gathered. The total market size is estimated as follows: Year 1: 800,000 units; Year 2: 1,200,000 units; Year 3: 600,000 units. Quarefel plc intends to use a flexible manufacturing system which will be able to produce up to 200,000 units per year. The equipment will cost $2,000,000 (payable year 0) and will have an estimated residual value of $400,000 (receivable at the end of year 4). An advertising campaign will be implemented by Quarefel plc on the following basis: Year 0: $1,200,000; Year 1: $1,000,000; Year 2: $800,000. Quarefel plc has estimated its sales (Q) in '000 units and selling price per unit (P) for each year over the life of the product. This may be expressed in terms of the price/demand function P=70-0.15Q. The year 1 market share is crucial. Annual sales units for Quarefel plc for years 2 and 3 are expected to increase or decrease from the year 1 level achieved in proportion to the change in the size of the overall market from one year to the next, in so far as the production capacity of Quarefel plc will allow. The prices set by Quarefel plc in each of years 2 and 3 will be set in accordance with the price/demand function estimate detailed above. Variable cost is estimated at $25 per product unit. Fixed costs directly attributable to the product (other than advertising) are estimated at $600,000 per year for each of years 1 to 3. Quarefel plc has an estimated cost of capital of 12% for this type of proposal. Ignore taxation and inflation. Required (a) Using the above information, calculate the net present value (NPV) and internal rate of return (IRR) of the proposal where a year 1 launch price of $60 per unit is used. (b) Briefly discuss three non-financial considerations in long-term decision making.
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