Jericho Manufacturing developed a new wireless phone charger which also uses the excess heat generated during the process to keep your coffee warm at a predetermined temperature.
The company is anxious to begin production of the new charger. To this end, marketing and cost studies have been made to determine probable costs and market potential. These studies have provided the following information:
New equipment would have to be acquired to produce the device. The equipment would cost $315,000 and have a 12-year useful life. After 12 years, it would have a salvage value of about $15,000.
Sales in units over the next 12 years are projected to be as follows:
Year Sales in Unites
1 60,000
2 12,000
3 15,000
4-12 18,000
Production and sales of the charger would require working capital of $60,000 to finance accounts receivable, inventories, and day-to-day cash needs. This working capital would be released at the end of the project's life.
The devices would sell for $35 each; variable costs for production, administration, and sales would be $15 per unit.
Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $135,000 per year. The depreciation is based on cost less salvage value.
To gain rapid entry into the market, the company would have to advertise heavily. The advertising program would be:
Year Annual Advertising Expenses
1-2 $180,000
3 $150,000
4- 12 $120,000
The company's board of directors has specified a required rate of return of 14% on all new products.
Requirements (Ignore income taxes)
You have been asked by your boss to evaluate the charger proposal from a capital budgeting perspective. You are to analyze the above data and prepare a memo to your boss recommending whether or not the company should accept the charger as a new product .
Supplemental tables should be included in your memo as necessary to explain amounts included in the memo and support your recommendation.
As part of your evaluation, you should perform the following at a minimum.
Compute the net cash inflow (cash receipts less yearly cash operating expenses) anticipated from sale of the device for each year over the next 12 years. A table supporting this computation should be included.
Using the data computed in (1) above and other data provided in the problem, determine each of the following for the proposed investment.
Tables supporting each computation should be included as part of your memo, as necessary.
Net present value
Internal rate of return
Payback period