Question

ABC MANUFACTURING INC.

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.

NOTE: This is an EXCEL-based task – BOTH tasks must be submitted as Excel uploads in the

respective drop box; in Task 2 please create separate sheets for questions 1 and 2.

For Task 1:

1. What is the NPV of this project?

2. What is the IRR of this project?

3. Should ABC produce this vacuum cleaner?

For Task 2:

1. How sensitive is the NPV to changes in the price per unit of this vacuum?

2. How sensitive is the NPV to changes in the quantity sold of this vacuum?

3. Should ABC produce this vacuum cleaner, given 1 and 2 above?