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Latest Motor Electronics (LME) is evaluating a proposal to create a new automated production process for a new product line. In the past year (year -1) $1 million has been spent researching this capability and it look promising. The proposal is to purchase machinery and install it this year (year 0). Next year (year 1) will be spent developing the capability (experimenting, debugging and training).

Shipments of products are expected to start in the following year (year 2) starting with $3,500,000 in revenues in that year and with a 25% growth annually in the years thereafter. COGS are forecasted to be 30% of revenues. Using a present worth criteria in a 5-year analysis, determine if it is financially justified to proceed with this project.

S.G.& A. are expected to be a constant $900,000 annually during the revenue years. In the development year, S.G. & A. is included in the Development estimate.

Investments should be depreciated using MACRS over 7 years and will have two components; one for the Machinery purchase and installation, and the other starting a year later for the Development investment. The depreciation starts in the year following when the investment is made. The salvage value is zero.

Ignore any Working Capital considerations.

Using the present worth criterion in a 5-year analysis (development year plus 4 revenue years), determine if it is financially justified to proceed with this project.

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Solution Summary

The expert examines MACRS evaluating proposals.

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Income Statement 0 1 2 3 4 5
Sales revenue $0 $3,500,000 $4,375,000 $5,468,750 $6,835,938
Cost of goods sold $0 ($1,050,000) ($1,312,500) ($1,640,625) ($2,050,781)
Gross Margin $0 $2,450,000 $3,062,500 $3,828,125 $4,785,156
General, Sales and ...

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