In: Accounting
Englewood Company has an opportunity to produce and sell a revolutionary new smoke detector for homes. To determine whether this would be a profitable venture, the company has gathered the following data on probable costs and market potential:
New equipment would have to be acquired to produce the smoke detector. The equipment would cost $100,000 and be useable for 12 years. After 12 years, it would have a salvage value equal to 10% of the original cost.
Production and sales of the smoke detector would require a working capital investment of $40,000 to finance accounts receivable, inventories, and day-to-day cash needs. This working capital would be released for use elsewhere after 12 years.
An extensive marketing study projects sales in units over the next 12 years as follows:
Year Sales in Units
1……………. 4,000
2……………. 7,000
3……………. 10,000
4-12………… 12,000
The smoke detectors would sell for $45 each; variable costs for production, administration, and sales would be $25 per unit.
To gain entry into the market, the company would have to advertise heavily in the early years of sales. The advertising program follows:
Amount of Yearly
Year Advertising
1-2…………. $70,000
3…………… $50,000
4-12……….. $40,000
Other fixed costs for salaries, insurance, maintenance, and straight-line depreciation on equipment would total $127,500 per year. (Depreciation is based on cost less salvage value.)
The company’s tax rate and required rate of return is 20%
Required: