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The Lawn Robot: Is it Really Worth it ? If there was one thing the folks at Creative Products Corporation knew well, it was how
The Lawn Robot: Is it Really Worth it
If there was one thing the folks at Creative Products Corporation knew well, it was how to come up with useful and unique products during the economic adversity. With the current years revenues considerably lower and profit margins shrinking due to severe price competition, the firms engineers had been pushed hard to develop a prototype of a useful, and hopefully highly profitable unique product. Last month, the design team unveiled a fully tested prototype of their latest innovation, a remotecontrolled lawn mower, the Lawn Robot. Surveys of retailers and customers conducted by the marketing department indicated that demand would be excellent, provided the price was lower than a riding lawn mower. The testing and development phases took almost three years, and the final product passed all safety hazard tests with flying colors. After the unveiling, the product was exhibited at various home shows nationwide and received race reviews. Full production has not yet started, however, because there had been a change in CEOs and the new CEO was highly conservative. Before being given to the go ahead to go into fullscale production of the Lawn Robot, the design team had to present a detailed feasibility study to the Capital Investment Committee CIC which was chaired by the Vice President of Finance, Bill Burton. As was typical for a major undertaking of this type, the proposal had to include detailed cost and revenue estimates with sufficient documentation to substantiate the numbers. Having been involved with more than a few of these kinds of proposals before, the head of the design team, Matt Robichek, knew that he had better take every possible factor into consideration and be prepared for a tough meeting and demanding question and answer session at the next committee meeting. Lucking for Matt, his assistant, Chris Robinson, who had recently earned his chartered financial analyst designation, was an experienced and dependable employee. Prior to being hired by CPC three years ago, Chris had worked for another large engineering company for over years. Chris we have to do all the Is and cross all the ts on this one said Matt. Or else the big guys are going to tear us apart, because we are talking major dollars here. Their main question is going to be is it worth it So Matt and Chris began collecting the necessary information. They knew that to have a comprehensive feasibility study they would have to include the following:
Pro forma statements showing expected annual revenues, variable costs, fixed costs and net cash flows over the economic life of the project with appropriate supporting documentation.
Breakeven analysis.
Sensitivity of the cash flows to alternative scenarios of sales growth and profit margins.
Based on the data provided by the marketing department, they prepared Table showing the expected unit sales of the Lawn Robot over its year economic life and the expected selling price per unit. Note that the price of $ per unit was estimated to gradually drop to $ per unit over the year period reflecting competitive pressures. Depreciation for this project was based on the sevenyear MACRS rates as shown in Table The cost of equipment, including shipping, handling, and installation, was estimated at $ million. It was estimated that after years, the equipment and tools could be sold for $ million. The manufacturing would be done in an unused plant of the firm. Similar plant locations could be leased for $ per month. Fixed costs were estimated to be $ per year while variable production costs per unit were expected to be $ To get the project underway, an additional inventory of $ would be required. The company would increase its accounts payable by $ and its account receivable by $ Matt and Chris estimated that each year thereafter, the net working capital of the firm would amount to of sales. The weighted average cost of capital was calculated to be Interest expenses on debt raised to fund the project to be $ per year. The companys tax rate was expected to remain constant at
Please prepare a proforma income statement showing the annual cash flows resulting from the Lawn Robot project.
Estimate the cash flows and calculate NPV and profitability index of the project? What do you recommend?
Calculate the IRR of the project. Based on your calculations, what would you recommend? Why?
Calculate the payback period and discounted payback period. If the companys expected payback period is years, what do you recommend? Why?
What could the maximum value of cost of capital that makes the company still to accept the project?
How should the annual interest expense of $ be treated? Explain.
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