Grace Corporation is an international manufacturer of fragrances for women. Management at Grace is considering expanding the product line to men’s fragrances. From the best estimates of the marketing and production managers, annual sales ( all for cash) for this new line is 1,400,000 units at $ 40 per unit; cash variable cost is $ 15 per unit; and cash fixed costs are $ 15,000,000 per year. The investment project requires $ 40,000,000 of cash outflow and has a project life of 6 years. At the end of the 6- year useful life, there will be no terminal disposal value. Assume all cash flows occur at year- end except for initial investment amounts. Men’s fragrance is a new market for Grace, and management is concerned about the reliability of the estimates. The controller has proposed applying sensitivity analysis to selected factors. Ignore income taxes in your computations. Grace’s required rate of return on this project is 16%.

1. Calculate the net present value of this investment proposal.
2. Calculate the effect on the net present value of the following two changes in assumptions. (Treat each item independently of the other.)
a. 10% reduction in the selling price
b. 10% increase in the variable cost per unit
3. Discuss how managers would use the data developed in requirements 1 and 2 when considering the proposed capital investment.

  • CreatedJanuary 15, 2015
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