Deciding which new product to develop using NPV
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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. Lava Rocks 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. See the bottom of the assignment for posting of ACC350_p3IPs.pdf 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)?
ACC350_p3IPs.pdf:
Proposal 1 Proposal 2
New product line Mid-level Entry-Level
Mountain Bike Hybrid Bike
Estimated first year revenues $600,000 $800,000
Estimated annual revenue growth 6% 4%
Estimated Contribution Margin % 40% 45%
Marginal Tax Rate (for tax benefit 40% 40%
calculation)
Estimated annual fixed costs $120,000 $100,000
Investment in Facility $1,500,000 $1,275,000
(expected salvage in year 6 of $400,000)
One-time Advertising (Year 0) $140,000 $150,000
Component inventory $150,000 $125,000
(value returned in full in year 6)
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Solution Summary
The solution explains how we can use NPV in making a decision on which new product to select for development
Solution Preview
The NPV calculations are in the attached file. The file has been made in such a manner that you can change the variables in the top rows to get new values of NPV. Since the project will get over in 5 years, the salvage value and the recovery of working capital will happen at the end of year5 itself and not in year 6 ( since we are ...
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