During college, John and Jane designed a consumer product and they are now consi
ID: 2818098 • Letter: D
Question
During college, John and Jane designed a consumer product and they are now considering whether they should start its commercialization or not. The product is No Snow, which they describe as a "nonconductive, heat coil filled tarp which fits smugly on your car or truck." John and Jane have already spent $50,000 in the design of the product. They have estimated that the start-up cost would be $400,000. In addition, they estimated fixed operating expenses per year (including opportunity costs) of $90,000 and a profit margin per unit (price minus average variable cost) of $95. John and Jane are uncertain about the demand for the product, but based on their research they were able to establish demand numbers for three alternative scenarios described in the following table Demand (Units Probability Year l Possible eman scenarios ear Year 3 and forever after of scenario 40% 55% 5% 500 1,000 5,000 500 3,000 50,000 500 5,000 20,000 oor rformance Good rformance Great rformance suppose that the risk-adjusted discount rate is 18% a) For each alternative scenario, calculate the cash flows per year and complete the table below Cash flows (S) Possible Year Year 2 Year 3 and forever after eman scenarios Poor Good Great b) Calculate the expected cash flows per year using the given probabilities c) What is the expected net present value of the project? d) Should Charles and Brooke commercialize the product? (explain clearly how you arrive at your conclusion) e) If Charles and Brooke start the commercialization and realize that the product is not successful (i.e. poor performance), should they stop the commercialization? (explain clearly how you arrive at your conclusion)Explanation / Answer
Answer a
Total profit
Total Cashflow
Year
Startup Cost (1)
Fixed operating cost (2)
Poor (4)
Good (5)
Great (6)
Poor (1+2+4)
Good (1+2+5)
Great (1+2+6)
0
-400000
-400000
-400000
-400000
1
-90000
47500
95000
475000
-42500
5000
385000
2
-90000
47500
285000
4750000
-42500
195000
4660000
3
-90000
47500
475000
1900000
-42500
385000
1810000
Demand in units
Total profit
Year
Profit per unit (3)
Poor (4)
Good (5)
Great (6)
Poor (3*4)
Good (3*5)
Great (3*6)
0
1
95
500
1000
5000
47500
95000
475000
2
95
500
3000
50000
47500
285000
4750000
3
95
500
5000
20000
47500
475000
1900000
Answer b.
Year
Startup Cost (1)
Fixed operating cost (2)
Exp profit(3)
Exp cashflow (1+2+3)
0
-400000
-400000
1
-90000
95000
5000
2
-90000
413250
323250
3
-90000
375250
285250
Demand in units
Total profit
Exp profit (with prob.)
Exp Profit'
Year
Profit per unit (3)
Poor (4)
Good (5)
Great (6)
Poor 7=(3*4)
Good 8=(3*5)
Great 9=(3*6)
10=7*0.40
11=8*0.55
12=9*0.05
10+11+12
0
1
95
500
1000
5000
47500
95000
475000
19000
52250
23750
95000
2
95
500
3000
50000
47500
285000
4750000
19000
156750
237500
413250
3
95
500
5000
20000
47500
475000
1900000
19000
261250
95000
375250
Answer C
Year
Startup Cost (1)
Fixed operating cost (2)
Exp profit(3)
Exp cashflow (1+2+3)
Dis @18%
Dis cashflow
0
-400000
-400000
1
-400000
1
-90000
95000
5000
0.847457627
4237.288136
2
-90000
413250
323250
0.71818443
232153.1169
3
-90000
375250
285250
0.608630873
173611.9564
NPV
10002.36149
Answer d
Since NPV is positive they should commercialise the project.
Answer E
In case of poor performance cashflow is not even meeting the fixed cost hence they should stop the commercialisation.
$50000 spend for design is sunk cost which is already incurred hence irrelevant for decision making.
Total profit
Total Cashflow
Year
Startup Cost (1)
Fixed operating cost (2)
Poor (4)
Good (5)
Great (6)
Poor (1+2+4)
Good (1+2+5)
Great (1+2+6)
0
-400000
-400000
-400000
-400000
1
-90000
47500
95000
475000
-42500
5000
385000
2
-90000
47500
285000
4750000
-42500
195000
4660000
3
-90000
47500
475000
1900000
-42500
385000
1810000
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