Hit or Miss Sports is introducing a new product this year. If its see-at-night s
ID: 2623347 • Letter: H
Question
Hit or Miss Sports is introducing a new product this year. If its see-at-night soccer balls are a hit, the firm expects to be able to sell 68,000 units a year at a price of $50 each. If the new product is a bust, only 48,000 units can be sold at a price of $45. The variable cost of each ball is $20, and fixed costs are zero. The cost of the manufacturing equipment is $7.8 million, and the project life is estimated at 10 years. The firm will use straight-line depreciation over the 10-year life of the project. The firm
Hit or Miss Sports is introducing a new product this year. If its see-at-night soccer balls are a hit, the firm expects to be able to sell 68,000 units a year at a price of $50 each. If the new product is a bust, only 48,000 units can be sold at a price of $45. The variable cost of each ball is $20, and fixed costs are zero. The cost of the manufacturing equipment is $7.8 million, and the project life is estimated at 10 years. The firm will use straight-line depreciation over the 10-year life of the project. The firm
Explanation / Answer
Hi,
Please find the detailed answer as follows:
Additional After Tax Cash Flow = Increase in Production*(Selling Price - Variable Cost)*(1-Tax Rate) = 43000*(50-25)*(1-.35) = 698750
We calculate the value assuming that the decision to expand the production is taken at the end of Year 1 after analyzing first year sales. So, we will calculate present value at end of 1st Year. We will use 9% annuity factor at 12%.
NPV as at the End of Year 1 = Additional After Tax Cash Flow*PVIFA(12%,9) = 698750*5.3282 = 3723079.75
Increase in NPV as of Today = 3723079.75/(1+.12)^1 = 3324178.35
Since the probability of outcome is 50% only, we would take = 3324178.35*50% = 1662089.175 or 1662089
Answer is $1662089
Thanks.
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