Hit or Miss Sports is introducing a new product this year. If its see-at-night s

Question

Hit or Miss Sports is introducing a new product this year. If its see-at-night soccer balls are a hit, the firm expects to be able to sell 57,000 units a year at a price of $50 each. If the new product is a bust, only 37,000 units can be sold at a price of $45. The variable cost of each ball is $20, and fixed costs are zero. The cost of the manufacturing equipment is $6.2 million, and the project life is estimated at 10 years. The firm will use straight-line depreciation over the 10-year life of the project. The firm’s tax rate is 35%, and the discount rate is 14%

If each outcome is equally likely, what is expected NPV?

Will the firm accept the project?

Suppose now that the firm can abandon the project and sell off the manufacturing equipment for $5.58 million if demand for the balls turns out to be weak. The firm will make the decision to continue or abandon after the first year of sales. What is expected NPV?

Does the option to abandon change the firm’s decision to accept the project?

If each outcome is equally likely, what is expected NPV?

Will the firm accept the project?

Suppose now that the firm can abandon the project and sell off the manufacturing equipment for $5.58 million if demand for the balls turns out to be weak. The firm will make the decision to continue or abandon after the first year of sales. What is expected NPV?

Does the option to abandon change the firm’s decision to accept the project?

Explanation / Answer

(I) NPV to carry on activities for 10 years.

Expected contribution margin under each outcomes are;

Total contribution margin   

=(U x CM)   

Each outcome is equally likely, means each has proballity 0.50,  Contribution Margin = CM

NPV is negative

(II) NPV for abondoned opearation after 1 year

NPV of proposed abondoned opeartion after first year is zero.

Out Come No.of units saleablle (U) CM per unit   

Total contribution margin   

=(U x CM)   

Hit 57,000 $50- $20 =$30 $1,710,000 Burst 37,000 $45-$20= $25 $925,000

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