water filters with The chief engineer for Portland Purifiers, a maker of industr
ID: 398820 • Letter: W
Question
water filters with The chief engineer for Portland Purifiers, a maker of industrial annual sales of $5 million, has an idea for a new product that would represent a major (and patentable) improvement over current market offerings. She estimates that the development of the product will cost half a million dollars, including tooling the manufacturing line. The last product launch cost about $200,000 in marketing and promotion costs. She thinks the product would sell for about $50,000 and should sell 75 units in year 1, 140 in year 2, and then level out at 200 per year. Contribution margin is 40 percent. Should the company continue with this project? What do you need to know about the company in order to un- derstand its decision to go or not go ahead? What is the payback period? 5.Explanation / Answer
5.
Value of annual sale in year 1 = 50000*75 = $3.75 Million
Value of annual sales in year 2 = 50000*140 = $7 Million
Value of annual sales year 3 and = $10 Million
Since the project of new product, gives considerable rise in revenue (over existing $5 M) from year 2 onwards, then the company 2 should pursue with this project of new product.
Further, the company should also find the rate of return, it demands from the investment. It is the ROI that must be earned by the company to accept the project. It is used to calculate the present value of the net cash inflows from the project. If it is higher than the investment then project is profitable, then it should be compared with the existing earnings. If new project delivers net cash benefits that is more than that of existing project, then new project should be accepted.
Payback period is the time taken up to recover the investment.
Investments made in the project = 500000 + 200000 = $700000
Net cash inflows in year 1 = 3750000*.4 = $1500000
Net cash inflows in year 2 = 7000000*.4 = $2800000
Payback period = 700000/1500000 = .467 year or 5.6 months
It means that the investment of $.7 Million will be recovered in 5.6 months.
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