Question

Your company is planning to add a new product to its line. To manufacture this product, the company needs to buy a new machine that costs $300,000 and has an estimated useful life of five years and a salvage value of 10% of its original cost. All sales will end up being for cash and all costs are out-of-pocket costs except for depreciation on the new machine. Additional information includes the following:

Item	Amounts
Expected New Product Annual Sales	$1,150,000
Expected New Product Annual Costs:
Direct Materials	$300,000
Direct Labor	$420,000
Overhead (excluding depreciation)	$210,000
Depreciation	$54,000
New selling, general, and admin (SGA)	$100,000
Discount rate	18%
Income tax rate	30%

Required:

1. What is the payback period for this product?
2. Briefly describe the 2 major limitations of the payback method.
3. Prepare a net present value (NPV) analysis for the proposed product.
4. What is the internal rate of return (IRR) for the proposed product?
5. Based on the above findings, should the new product be approved? Why or why not?

Answer 1