Question

An engineering design company is deciding between the development of two products that have been pitched by different design teams.

Your task is to compare the two products using a break even analysis and make a recommendation to management about which product to go ahead with.

1. For Product 1:

1. 1. Calculate how long it will take to break even for Product 1 (answer in years and months).
   2. What is the initial investment required? (1 mark)
   3. What will the profit be after 5 years of selling the Product 1 as planned?
2. For Product 2:
   1. Calculate how long it will take to break even for Product 2 (answers in years and months).
   2. What is the initial investment required? (1 mark)
   3. How long will it take to make the same profit as calculated in setion 1c) (ie same profit as Product 1 after 5 years)?
3. Which product will you recommend that the company goes ahead with and why?
4. If you could make a change to the design or manufacture to improve the financial side of your suggested product, where would you focus your changes and why?

Product 1:

• Engineers have spent $150 000 in costs designing and prototyping the product and getting consultants in to help with specialised knowledge
• Engineers budgetted an additional $225 000 in costs for outsourcing arrangements for manufacture, storage and delivery of the designed product.
• The outsourcing company will charge $2200 to manufacture each unit.
• In addition, each product is expected to cost an additional $50 in administration costs for the company.  
• In order to be successful in the market, they believe this product will need to have a sales price of $3250
• They expect to be able to sell 100 units per year

Product 2:

• Engineers have spent $32 000 in costs designing and prototyping the product
• Engineers budgetted an additional $55 000 in costs to buy equipment and finalise the design
• Each product will cost $35 to manufacture
• In order to be successful in the market, they believe this product will need to have a sales price of $47
• They expect to be able to sell 2500 units per year

Answer 1

Let us first look at Project 1

Project 1

Per unit details
manufacturing cost	2200
Admin cost	50
selling price	3250
Units	100

According to the above conditions, we build out a cash flow table for years 1-5

Each year cash flow = 100 * (Selling price - manufacturing cost - admin cost)

Cash Flow Table
1	2	3	4	5
100,000	100,000	100,000	100,000	100,000

Since the Initial investment is = 150,000 + 225,000 = 375,000

It will take Project 1 - 3 Years and 9 months to break evenP

Profit after selling goes as planned after 5 years = 500,000 - 375,000 = 125,000

Now we will look at Project 2

Per unit details
manufacturing cost	35
selling price	47
Units	2500

According to the above conditions, we build out a cash flow table for years 1-5

Each year cash flow = 2500 * (Selling price - manufacturing cost )

Cash Flow Table
1	2	3	4	5
30,000	30,000	30,000	30,000	30,000

Initial cost = 32,000 + 55,000 87,000

Break even time 2 years 9 Months

It will take 7 years and 1.1 months to reach the same level of profitability as Project 1

I would recommend Project 1, as it gives a better profitability

I would like to re-negotiate the outsourcing cost of Project 1, to bring it down so that it is further more profitable