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In: Finance

The Picture-Perfect Company is considering whether it should introduce a new product, a camera lens. However,...

The Picture-Perfect Company is considering whether it should introduce a new product, a camera lens. However, they are unsure of the demand for the product and have hired a consultant to do some market research for them before moving forward. The consultant fee is $10,000. If the company produces the lens, it will have to invest $400,000 in new equipment, and $25,000 in working capital. The equipment will last for the duration of the project, which is 3 years, and will be depreciated to zero using straight-line depreciation. In 3 years, the equipment is expected to have a scrap value of 5,000. The lens is expected to produce $300,000 per year in revenues and create operating costs of $100,000 per year. If the lens is produced, Picture-Perfect expects to lose $25,000 per year from the decline in demand for a lens the company is currently selling. If the company has a tax rate of .21 and the project has a required return of .08, should Picture-Perfect move ahead with the new product?

Solutions

Expert Solution

The consultant fee of $10,000 is a sunk cost and hence irrelevant in capital budgeting.

Please see the table below. Please be guided by the second column titled “Linkage” to understand the mathematics. The last row highlighted in yellow is NPV. Figures in parenthesis, if any, mean negative values. All financials are in $. Adjacent cells in blue contain the formula in excel I have used to get the final output.

Since, NPV of the project is positive, Picture-Perfect should move ahead with the new product

jeff jeffy answered 8 months ago
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