Senior management is considering two proposals to expand the product line. Expansion of the product line requires a new facility and production team. Senior management hired a consulting firm to research the potential product lines. The ACME Company would like to make this product line for at least 5 years (so the evaluation is for 5 years of revenues and costs). You were at a meeting with the researchers and they gave you the results of the research in a table below to use for the results of their research. Create a presentation that you will make to management. Use the following assumptions:
Assume the risk-adjusted cost of capital is 12%, compute net present value (NPV) for each proposal. Include the cash flows from salvage value and the tax benefits of depreciation (assume 5-year straight-line). Incorporate the research data and graphs and charts into your presentation for support to your recommendation.
Include in your presentation recommendations on the product line for senior management? Specify how your recommendation is affected by your assumptions for cost of capital and expected contribution margin (that is, perform a sensitivity analysis)?
Proposal 1 Proposal 2
New Product Line Gadget A ( Mid-Level) Gadget B (Entry-Level)
Estimated First Year Revenue $600,000 $800,000
Estimated Annual Revenue Growth 6% 4%
Estimated Contribution Margin 45%
Estimated Annual Fixed Costs $120,000 $100,000
Investment in Facility
(Expected Salvage in 6 years of
$400,000) $1,500,000 $1,275,000
One Time Advertising Year (0) $140,000 $150,000
(Value returned in full in year 6) $150,000 $125,000
Product line proposal options are outlined in an Excel file showing the benefits of each.