Question

Anderson Company has an opportunity to produce and sell a revolutionary new carbon monoxide detector for homes. To determine whether this would be a profitable venture, the company has gathered the following data on probable costs and market potential. A. New equipment would have to be acquired to produce the carbon monoxide detector. The equipment would cost $100,000 and be usable for 12 years. After 12 years, it would have a salvage value equal to 10% of the original cost. B. Production and sales of the carbon monoxide detector would require a working capital investment of $35,000 to finance accounts receivable, inventories, and day-to-day cash needs. This working capital would be released for use elsewhere after 12 years. (hint: this will be a cash outflow at the beginning of the project and a cash inflow at the end of year 12) C. An extensive marketing study projects sales in units over the next 12 years as follows. Year Sales in Units 4,000 7,000 10,000 12,000 3 4-12 D. The carbon monoxide detectors would sell for $45 each; variable cost for production, administration and sales would be $25 per unit. E. To gain entry into the market, the company would have to advertise heavily in the early years of sales. The advertising program follows. Year Amount of yearly advertising $70,000 $50,000 $40,000 1-2 4-12

Answer 1

	Year
	1	2	3	4 to 12
Sales (Units) -A	4000	7000	10000	12000
Selling Price -B	45	45	45	45
Variable Cost per unit -C	25	25	25	25
***It is assumed that 12000 units per year from year 4 to 12, Please let me know if it is wrong

Cost of Equipment	100000
Salvage value(10%)	10000
Life (years)	12
Depreciation Per year	7500
(100000-10000)/12
Working Capital Required	35000

1.

	Year
	1	2	3	4	5	6	7	8	9	10	11	12
Sales Value (A*B)	180000	315000	450000	540000	540000	540000	540000	540000	540000	540000	540000	540000
Variable Cost (A*C)	-100000	-175000	-250000	-300000	-300000	-300000	-300000	-300000	-300000	-300000	-300000	-300000
Advertising Expenses	-70000	-70000	-50000	-40000	-40000	-40000	-40000	-40000	-40000	-40000	-40000	-40000
Other Fixed Costs	-127500	-127500	-127500	-127500	-127500	-127500	-127500	-127500	-127500	-127500	-127500	-127500
Add Back- Depreciation	7500	7500	7500	7500	7500	7500	7500	7500	7500	7500	7500	7500
(Non Cash expense)
Operating Cash inflow	-110000	-50000	30000	80000	80000	80000	80000	80000	80000	80000	80000	80000

2.

Annual Free Cash flow
Year	Operating Cash inflow	PV factor @18%	Present value of Cash inflow
1	-110000	0.847	-93170
2	-50000	0.718	-35900
3	30000	0.609	18270
4	80000	0.516	41280
5	80000	0.437	34960
6	80000	0.37	29600
7	80000	0.314	25120
8	80000	0.266	21280
9	80000	0.225	18000
10	80000	0.191	15280
11	80000	0.162	12960
12	80000	0.137	10960
	35000	0.137	4795
	10000	0.137	1370
	635000		104805
Initial investment			100000
Working Capital Required			35000
Total Initial outlay			135000
Net Present Value			-30195
(104805-135000)

working capital no longer required	35000
Salvage value	10000

3. Since the Net Present value of new proposal is negative, it mean the proposal is not feasible. It is better to reject the proposal.

Hope you Understood.

If you have any doubt please leave a comment. Thank you.