Englewood Company has an opportunity to produce and sell a revolutionary new smo
ID: 2393100 • Letter: E
Question
Englewood 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:
New equipment would have to be acquired to produce the smoke detector. The equipment would cost $100,000 and be useable for 12 years. After 12 years, it would have a salvage value equal to 10% of the original cost.
Production and sales of the smoke detector would require a working capital investment of $40,000 to finance accounts receivable, inventories, and day-to-day cash needs. This working capital would be released for use elsewhere after 12 years.
An extensive marketing study projects sales in units over the next 12 years as follows:
Year Sales in Units
1……………. 4,000
2……………. 7,000
3……………. 10,000
4-12………… 12,000
The smoke detectors would sell for $45 each; variable costs for production, administration, and sales would be $25 per unit.
To gain entry into the market, the company would have to advertise heavily in the early years of sales. The advertising program follows:
Amount of Yearly
Year Advertising
1-2…………. $70,000
3…………… $50,000
4-12……….. $40,000
Other fixed costs for salaries, insurance, maintenance, and straight-line depreciation on equipment would total $127,500 per year. (Depreciation is based on cost less salvage value.)
The company’s required rate of return is 20%
Required:
(6 points) Compute the net cash inflow (cash receipts less yearly cash operating expenses) anticipated from the sale of the smoke detectors for each year over the next 12 years.
(4 points) Using the data computed in (1) above and other data provided in the problem, determine the net present value of the proposed investment. Would you recommend that Englewood Company accept the smoke detector as a new product?
Explanation / Answer
Net cash flows Year-1 Year-2 Year-3 Year 4-6 Sales units 4000 7000 10000 12000 Selling price per unit 45 45 45 45 Less: Variable cost per unit 25 25 25 25 Contribution margin per unit 20 20 20 20 Contribution margin earned 80000 140000 200000 240000 Less: Other fixed cost excl. dep 120000 120000 120000 120000 (127500-7500) Less: Advertisement expense 70000 70000 50000 40000 Net cash flows -110000 -50000 30000 80000 Net present value Year-0 Year-1 Year-2 Year-3 Year-4 Year5 Year-6 Initial investment -100000 Working capital -40000 Cash flows -110000 -50000 30000 80000 80000 80000 Release of working capiptal 40000 Salvage value 10000 Net cash flows -150000 -110000 -50000 30000 80000 80000 130000 PVF @ 20% 1 0.833333 0.694444 0.578704 0.482253 0.401878 0.334898 Present value of cash flows -150000 -91666.7 -34722.2 17361.11 38580.25 32150.21 43536.74 NPV -144760 No, Company should not accept the order.
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