Question

ABC Manufacturing Inc., a firm based in California has spent $750,000 to develop a new,

efficient vacuum cleaner. The firm has also spent another $250,000 on market research to

estimate possible sales of this new vacuum, and the market research firm has given them the

following figures:

Year 1 – 60,000 units

Year 2 – 100,000 units

Year 3 – 150,000 units

Year 4 – 70,000 units

Year 5 – 50,000 units

The variable costs of manufacturing are $175 per unit in year 1 and the fixed costs of operations

are $3.5 million a year. The sales price per unit will be $475 per unit in year 1. Both sales price

and variable costs are estimated to increase by 5% (rounded off to the nearest whole dollar). The

necessary equipment can be purchased for $30 million and will be depreciated on a seven-year

MACRS schedule. The salvage value at the end of 5 years is believed to be $5 million. Initial net

working capital is $4 million to start – and will be 20% of sales for each year from years 2

through 5, to be budgeted for at the end of the previous year. ABC has a 35% corporate tax rate

and a 12% required rate of return.