Capital Budgeting
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Batteries Inc. is considering developing a new long life battery for cell phones. You can invest immediately and start production right away.
Research effort cost $1m, marketing effort cost $0.5m (these are sunk costs)
Production equipment cost $1m and will have a useful life of 5 yrs and will depreciate using the straight line method. At year 4 you believe you can sell the equipment for $0.3m
Net working capital will increase by $1m immediately and be recaptured at year 4.
There are 2 separate customer bases for the batteries:
1) New cell phones- for every new cell phone, one battery will be used. Internal transfer price is $2 now and variable cost per battery to produce is 50 cents.
Production of new cell phone batteries will be 300,000 in first yr and will increase by 10% per year.
2) Existing cell phones- wholesale price is $10 per battery now and variable cost per battery is 50 cents.
Demand for existing cell phone batteries is 1m in first year and will increase by 10% per year. Out of the demand for batteries for the exiting cell phones this company expects to capture 80%.
Battery price and cost will rise 2% above inflation rate. Marketing & admin. fees will cost $0.5m first yr and rise at inflation each year after. Inflation will remain constant at 3%. Tax rate is 34%. Discount rate is 15%.
Please calculate company's payback period, accounting rate of return, NPV and profitability index and show the formula.
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Solution Summary
The solution explains the calculation of payback period, accounting rate of return, NPV and profitability index
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1. Payback period is when the initial investment is ...
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