2. Your company wants to launch a new product. R&D; (including prototypes and ma

Question

2. Your company wants to launch a new product. R&D; (including prototypes and manufacturing process development will take 1 year and cost $60,000. You will need a special measuring machine, which you will lease at $10,000 per quarter: no other new equipment will be required. Fixed costs (rent, insurance, etc) for the area of the factory where the R&D; will be done and the units will be produced is $5000 per quarter. The cost of goods sold (including all materials, power, labor, etc) will be $2000 for each unit. Marketing estimates that they can sell 10 units in the first quarter after launch, ramping up to 15 in second and 20 in future quarters at a price of $8000 each. Stating any assumptions you make: i) When will the project break even? ii) Draw a cash flow diagram for 3 years from the start of R&D.; iii) Compute the present worth of the project.

Explanation / Answer

Answer i

Break even = Fixed cost / contribution per unit = $10000+ $5000 / ($8000 - $2000) = $15000/ $6000 = 2.5 units per quarter.

Note: R& D cost being a sunk cost is not considered for break even and deciosn making purpose. The fixed cost of leasing and other rent and insurance cost is considered.

Answer ii

Answer iii

Assuming a disocunt rate of 10 %, and taking the life of product as 3 years and further assuming that the sale price and COGS and other fixed cost will remain same for 3 years.

The present worth of the project is

Quarter 0 1 2 3 4 5 6 7 8 9 10 11 12 Total Units sold 10 15 20 20 20 20 20 20 20 20 20 20 Sale price $8,000 $8,000 $8,000 $8,000 $8,000 $8,000 $8,000 $8,000 $8,000 $8,000 $8,000 $8,000 Less: cost of goods sold $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 Contribution per unit $6,000 $6,000 $6,000 $6,000 $6,000 $6,000 $6,000 $6,000 $6,000 $6,000 $6,000 $6,000 Contribution value $60,000 $90,000 $120,000 $120,000 $120,000 $120,000 $120,000 $120,000 $120,000 $120,000 $120,000 $120,000 $1,350,000 Less: fixed cost Lease cost $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 Other (rent/ insurance etc) $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 Total cash inflow/ Profit $45,000 $75,000 $105,000 $105,000 $105,000 $105,000 $105,000 $105,000 $105,000 $105,000 $105,000 $105,000 $1,170,000

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