Response to the following problem:
Simtex Ltd has invested £120,000 to date in developing a new type of shaving foam. The shaving foam is now ready for production and it has been estimated that the new product will sell 160,000 cans a year over the next four years. At the end of four years, the product will be discontinued and replaced by a new product. The shaving foam is expected to sell at £6 a can and variable costs are estimated at £4 a can. Fixed costs (excluding depreciation) are expected to be £300,000 a year. (This figure includes £130,000 in fixed costs incurred by the existing business that will be apportioned to this new product.) To manufacture and package the new product, equipment costing £480,000 must be acquired immediately. The estimated value of this equipment in four years' time is £100,000. The business calculates depreciation using the straight-line method, and has an estimated cost of capital of 12 per cent.
Required:
(a) Deduce the net present value of the new product.
(b) Calculate by how much each of the following must change before the new product is no longer profitable.
(i) The discount rate.
(ii) The initial outlay on new equipment
(iii) The net operating cash flows.
(iv) The residual value of the equipment.
(c) Should the business produce the new product?