Question
RET Inc. currently has one product, low-priced stoves. RET Inc.has decided to sell a new line of medium-priced stoves. Sales revenues for the new line
RET Inc. currently has one product, low-priced stoves. RET Inc.has decided to sell a new line of medium-priced stoves. Sales revenues for the new line of stoves are estimated at $20 million a year. Variable costs are 80% of sales.The project is expected to last 10 years. Also,non-variable costs are $2,000,000 per year. The company has spent $3,000,000 in research and a marketing study that determined the company will lose (cannibalization) $4 million in sales a year of its existing low-priced stoves. The production variable cost of the existing low-priced stoves is $2 million a year.
The plant and equipment required for producing the new line of stoves costs $20,000,000 and will be depreciated down to zero over 20 years using straight-line depreciation. It is expected that the plant and equipment can be sold (salvage value) for $12,000,000 at the end of 10 years. The new stoves will also require today an increase in net working capital of $3,000,000 that will be returned at the end of the project.
The tax rate is 30 percent and the cost of capital is 10%.
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