Case Scenario:
Seating Unlimited Inc. is considering producing a specialty lawn chair for the next Olympics, which will occur in two years. The new production line will require a $100,000 investment in fixed assets which will fall into the MACRS five-year class. The firm's market research department anticipates sufficient demand for the lawn chairs for only three years. At the conclusion of the project the fixed assets can be sold for $25,000.
The market research team believes one of three states of nature will occur, depending on the level of interest in the Olympics. The three states are high, average, or low consumer interest in the Olympics. The firm has estimated unit sales, the sales, price, and variable costs for each state:
Consumer interest Units sales Sales price per unit Variable cost per unit
low 50,000 $6.25 $3.50
average 100,000 $8.00 $3.50
high 150,000 $10.00 $5.00
Note that the level of consumer interest remains constant over the estimated life of the project (if interest is low in the first year, interest will be low for the remaining periods). THe project will have fixed costs of $150,000 per year. Project net working capital requirements are estimated to be 20% of year one expected sales. The firm has a 7% cost of capital and a tax rate of 39%.
Set up a spreadsheet containing the relevant information. Create a worksheet for each scenario; calculate annual project cash flows.
1. What is the NPV for each scenario? Based on your results, should the firm undertake the project?