Question

CHIcal TIMIKUTY CT-1 LO 134 Hocus Pocus Company wants to increase sales by adding a new product line. The company is considering three different projects. However, its capital budget is limited to $1,500,000. In addition, the company requires a rate of return of 10%. The information concerning the three product lines is given below. Broomsticks $1,170,000 Magic Wands $983,000 Crystal Balls $2,210,000 Net Initial Investment Budgeted Income Statement for the next five years: Sales Cost of Goods Sold Gross Margin Marketing and Administrative Expenses Net Income* $500,000 80,000 420,000 100,000 $450,000 50,000 400,000 130,000 $650,000 32,000 618,000 22.000 *Assume all amounts stated on the budgeted income statement are cash items.

• A) Determine the net present value for each project assuming all cash flow cease after 5 years.

  B) Which project should hocus pocus invest in and why?

  C) If hocus pocus had a capital budget limit of 2,300,000, how should they invest it?

Answer 1

Answer is given below

Sales COGS Gross margin Marketing and administrative expenses Net Income/Cash inflows Broomsticks Magic Wand Crystal Balls $500,000 $450,000 $650,000 $80,000 $50,000 $32,000 $420,000 $400,000 $618,000 $100,000 $130,000 $22,000 $320,000 $270,000 $596,000 Present value factor of 10% 3.79079 3.79079 3.79079 Present value of cash inflows Initial investment Net present value $1,213,052 $1,170,000 $43,052) $1,023,512 $983,000 $40,512 $2,259,309 $2,210,000 $49,309 B Hocus Pocus should invest in Broomsticks if budget is $1,500,000 NPV of Broomsticks is higher and investment is within budget C Hocus Pocus should invest in Broomsticks and Magic Wands if budget is $2,300,000 Combined Investment is $2,153,000 Combined NPV is $83,564