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:

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.

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.

An extensive marketing study projects sales in units over the next 16 years as follows:

    

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:

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.)

Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables.

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.

Using the data computed in (1) above and other data provided in the problem, determine the net present value of the proposed investment. (Negative amount should be indicated by a minus sign. Use the appropriate table to determine the discount factor(s) and round final answers to the nearest dollar amount.)

Would you recommend that Starlight Company accept the smoke detector as a new product?

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:

Explanation / Answer

Solution:

1.

2a.

1/1.07^1 = 0.934579, 1/1.07^2 = 0.873439, 1/1.07^3 = 0.816298,

*Present value Factor For 16 periods 9.4466

Present value Factor For 3 periods (2.624)

Present value Factor For 13 periods, starting 4 periods in the Future 6.8223

2b. Since the net present value is negative, thecompany should not accept the smokedetector as a new product.

Year 1 2 3 4-16 Sales 2000 5000 8000 10000 Sales (in dollars $45 each) 90000 225000 360000 450000 Less: variable expenses @ 25 each 50000 125000 200000 250000 Contribution margin 40000 100000 160000 200000 Less: fixed expenses Advertising 74000 74000 53000 43000 Other fixed expenses* 117625 117625 117625 117625 Total fixed expenses 191625 191625 170625 160625 Net cash inflow (outflow) -151625 -91625 -10625 39375 *Depreciation is not a cash outflow and therefore must be eliminated when determining the net cashflow depreciation Cost of the equipment $140,000 Less salvage value (10%)10,000 $14,000.0 Net depreciable cost $126,000.0 $126,000/16 Depreciation $7,875.0

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