Question
Starlight Company has an opportunity to produce and sell a revolutionary new smoke detector for homes.To determine whether this would be a profitable venture, the
Starlight Company has an opportunity to produce and sell a revolutionary new smoke detector for homes.To determine whether this would be a profitable venture, the company has gathered the following data on probable costs and market potential: |
a. | New equipment would have to be acquired to produce the smoke detector. The equipment would cost $140,000 and be usable for 16 years. After 16 years, it would have a salvage value equal to 10% of the original cost. |
b. | Production and sales of the smoke detector would require a working capital investment of $44,000 to finance accounts receivable, inventories, and day-to-day cash needs. This working capital would be released for use elsewhere after 16 years. |
c. | An extensive marketing study projects sales in units over the next 16 years as follows: |
Year | Sales in units |
1 | 2,000 |
2 | 5,000 |
3 | 8,000 |
4-16 | 10,000 |
|
d. | The smoke detectors would sell for $45 each; variable costs for production, administration, and sales would be $25 per unit. |
e. | To gain entry into the market, the company would have to advertise heavily in the early years of sales. The advertising program follows: |
Year | Amount of yearly advertising |
1-2 | $74,000 |
3 | $53,000 |
4-16 | $43,000 |
|
f. | Other fixed costs for salaries, insurance, maintenance, and straight-line depreciation on equipment would total $125,500 per year. (Depreciation is based on cost less salvage value.) |
g. | The companys required rate of return is 7%. (Ignore income taxes.) |
Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables. |
Required: | |
1. | Compute the net cash inflow (cash receipts less yearly cash operating expenses) anticipated from sale of the smoke detectors for each year over the next 16 years. |
The net cash inflow from sales of the device for each year would be: |
ar 1 | Year 2 | Year 3 | Year 4-16 | |
Sales in units | 2,000 | 5,000 | 8,000 | 10,000 |
Sales in dollars | ||||
Less variable expenses | - | |||
Contribution margin | 0 | 0 | 0 | 0 |
Less fixed expenses: | ||||
Advertising | ||||
Other fixed expenses | ||||
Total fixed expenses | ||||
Net cash inflow (outflow) | $0 | $0 | $0 | $0 |
2a. | Using the data computed in (1) above and other data provided in the problem, determine the net present value of the proposed investment. (Negative amount should be indicated by a minus sign. Use the appropriate table to determine the discount factor(s) and round final answers to the nearest dollar amount.) | |||||
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2b. | Would you recommend that Starlight Company accept the smoke detector as a new product? | ||||
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