Question

1 ERS Ltd is considering the launch of a new product after an extensive market research whose costs were $20,000. The research cost is due for payment in a months' time. The management accountant has prepared the following forecasts for the product. Year 1 2 3 4 $ $ $ $ Sales 215,000 ... 200,000 150,000 120,000 Material cost. (115,000) (140,000) (110,000) (85,000) Variable overheads. (27,000) (30,000) (24,000) (18,000) Fixed overheads. (25,000) (25,000) (25,000) (25,000) Market research cost expensed. (20,000) Net proflt/tloss). (7,000) 5,000 1,000 (8,000) The CEO pointed out that the product achieved profits in only two years of its four-year life and that over the four-year period as a whole, a net loss was expected. However, before a meeting that had been arranged to decide formally the future of the product, the following additional information became available: 1. The new product will require the use of an existing machine. This machine was acquired some time back for $400,000 and has since been depreciated down value to a book value of$80,000. The machine can be sold for $90,000 immediately if the new product is not launched. lfthe product is launched, it will be sold at the end of the four-year period for $15,000. '\ 11. If the product is launched, a marketing cost of $1 ,000 per year will be incurred due to social media adverts expected to be used. This cost is included in the projected fixed overhead value reported each year. 12. Additional working capital of 10% of sales revenue each year will be required through- out the four-year period. It will be released at the end of the investment period. iv. The fixed overheads include a figure of$ 15,000 per year for depreciation of the machine and $5,000-Per year for the re-allocation of existing overheads of the business. v. All the values above are in money terms except for variable overheads which are in current price terms. Variable overhead inflation is 2% per year. vi. The money cost of capital is 11 % . Ignore taxation. REQUIRED Identify the relevant cash flows associated with the the decision to launch the new product and determine the net cash flows for each year(year 0to 4). Comment why you have omitted specific figures in (a) above ( if any).

Answer 1

a. Relevant Cash Flows for the project

b. The following costs were not considered in the statement

i. initial market research cost of 20000 is not considered because the cost will not enhance or decrease the sales or costs of the expected cash flows thus it is treated as sunk cost

ii. Depreciation is not considered as it an non cash expenses

iii. Fixed Overhead reallocated is not considered as such expense will be incurred irrespective of the product implementation