QUESTION. Assuming that Photonics has unlimited funding, which products should Photonics launch? Support your recommendation by providing an analysis on each products projected cash flow over a 5-year period and the overall economic value that each product launch provides. You will need to integrate the principles of capital budgeting decision-making in your analysis.

For all projects assume a 20% tax rate on net income.

OxyAlertII

The marketing department believes that this product will not completely replace OxyAlert, as there will still be some customers who will want the older and cheaper version. However, they do believe that there could be some sales cannibalization of the old product. In the next five years, sales for OxyAlert are forecasted to steadily decrease by 10% each year in the North American market. First year sales of OxyAlertII are projected to be $52 million with a 16% increase in revenue each year through year 5. In the prior two years the company has spent $15 million to develop this product. To manufacture this new product, Photonics contract manufacturer requires an additional $25 million investment in new equipment purchases. Photonics will agree to pay 100% of this investment and in turn will own the equipment outright. This equipment will have a 5-year life and will depreciate by $5 million per year. With this new equipment the contract manufacturer will be able to produce the product at a lower cost. As a result, Photonics cost of goods sold will be only 35% of revenue, which is much lower than current costs. Incremental administrative and overhead expense will be 35% of revenue. Working capital requirements will be 12% of revenue. In order to successfully launch this product, the marketing department is requesting a one-time advertising budget of $30 million, which will be spent in the first year of sales.

AutoAnalytics

This product is neither a complimentary product nor a replacement product for OxyAlert. The launch of this product is intended to create a new product line by extending Photonics core competencies into the emergency response market. The marketing department forecasts first year revenue at $30 million with initial one-time marketing expense of $25 million. Based on projected demand, revenue is expected to increase by 10% year over year for the remaining 4 years. Prior years development cost for this product has totaled $10 million dollars. The contract manufacturer estimates that it will need an additional $15 million dollars in new equipment purchases to manufacture this product. Because the equipment can be repurposed for other customers, Photonics will not pay the contract manufacturer for this equipment and will be owned outright by the contract manufacturer. Because of the lack of experience in manufacturing this type of product, the contract manufacturer expects the cost to make this product will be somewhat high. As a result, cost of goods sold will increase to 41% of revenue. Incremental SG&A will be 27% of revenue with an additional working capital requirement of 15% of revenue.

Diagnostic Solutions

Diagnostic Solutions is a series of networked probes that will allow customers to use OxyAlert in more efficient ways. Marketing believes that this complimentary product will actually help the sales of OxyAlert and prevent the full adoption of your competitors product, TotalDiagnostic, in the marketplace. Market share for OxyAlert is projected to slightly increase by 2 percent over the next 5 years. Your finance team believes that this will provide an additional $3.5 million of after-tax cash flow per year in this five-year time period. While this product will help the sales of OxyAlert, it will be sold separately. Revenue projections for Diagnostic Solutions will be $17 million in the first year of sales. Since this is already a fairly saturated market, the sales of Diagnostic Solutions are projected to increase by only 2% per year over the next five years. As this is a complimentary product, the development cost was nominal. The company will, however, need to expand its warehouse facilities. This will require an additional $20 million of capital. The economic useful life of this equipment is 7 years and will depreciate by $2.8 million per year. Your incremental cost of goods sold will be 40% of revenue. Incremental overhead and administrative cost will be 33%. Projected working capital will be 19% of revenue. Given that this is a complimentary product, you will not incur any additional one-time marketing expenses for launching this product.