Question: Plato Pharmaceuticals Ltd. has invested $100,000 to date in developing a new type of insect repellent. The repellent is now ready for production and sale, and the marketing manager estimates that the product will sell 150,000 bottles a year over the next five years. The selling price of the insect repellent will be $6 a bottle and variable costs are estimated to be $3 a bottle. Fixed costs (excluding amortization) are expected to be $200,000 a year. The figure is made up of $160,000 additional fixed costs and $40,000 fixed costs relating to the existing business that will be apportioned to the new business.
In order to produce the repellent, machinery and equipment costing $520,000 will have to be purchased immediately. The estimated residual (salvage) value of this machinery and equipment in five years time is $100,000. The business calculates depreciation following CCA rules.
The business has a cost of capital of 12%. CCA 30% (50% rule applicable) of depreciation will be used, and taxes are paid at a rate of 40%.
Required: Undertake sensitivity analysis to show how much the following factors would have to change before the product ceased to be worthwhile.
a. The initial cost of machinery and equipment
b. Operating costs - Fixed
c. Operating costs - variable
d. Price per bottle of repellent
e. The residual value of the machinery and equipment