Starlight Company has an opportunity to produce and sell a revolutionary new smo

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 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 company’s 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:

2a. Using the data computed in (1) above and other data provided in the problem, determine the net

Explanation / Answer

1)

Year 0 Cash Flow = -New Equipment Cost - Working Capital

Year 0 Cash Flow = -140000-44000

Year 0 Cash Flow = -184000

Annual Depreciation = (Cost-Salvage Value)/useful life

Annual Depreciation = (140000-14000)/16

Annual Depreciation = 7875

Year 1 Cash Flow = (Sale Price - Variable cost per unit)*Unit Sold -Advertising Cost- Fixed cost + Annual Depreciation

Year 1 Cash Flow = (45-25)*2000-74000 - 125500 + 7875

Year 1 Cash Flow = - 151625

Year 2 Cash Flow = (Sale Price - Variable cost per unit)*Unit Sold -Advertising Cost- Fixed cost + Annual Depreciation

Year 2 Cash Flow = (45-25)*5000-74000 - 125500 + 7875

Year 2 Cash Flow = - 91625

Year 3 Cash Flow = (Sale Price - Variable cost per unit)*Unit Sold -Advertising Cost- Fixed cost + Annual Depreciation

Year 3 Cash Flow = (45-25)*8000-53000 - 125500 + 7875

Year 3 Cash Flow = - 10625

Year 4 to Year 16 Cash Flow = (Sale Price - Variable cost per unit)*Unit Sold -Advertising Cost- Fixed cost + Annual Depreciation

Year 4 to Year 16Cash Flow = (45-25)*10000-43000 - 125500 + 7875

Year 4 to Year 16 Cash Flow = 39375

2a.

Net Present Value = -184000 - 151625/1.07 - 91625/1.07^2 - 10625/1.07^3 + (39375*(1-(1+7%)^-13)/7% )/ 1.07^3

Net Present Value = -145,778.25

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