ITS Ltd is an electronics company which commenced business two decades earlier. It has an established product base and a set of loyal customers. The company is planning to introduce a new product that apparently has a tremendous scope in the long run. The capital costs of development would be huge, but if the product succeeds, the demand will be large and stable. The company is considering whether to take up the new product development which will entail substantial outgo initially, followed of course by long-term cash inflows. 

The relevant figures are as follows:

• The initial investment will be ₹1 billion in the first year and ₹ 0.50 billion in the second.
Sales in the year after the project commences are likely to be 1,000 units, with an increase of 200 units per annum in subsequent years.
• The price per unit is ₹600,000. The company is confident of increasing the price by ₹100,000 from the third year onwards every year without impacting the projected sales.
• The variable costs per unit are extremely low at ₹50,000, comprising mainly of marketing expenses.
• The depreciation is calculated at 20 per cent of the gross capital. Investment of ₹1 billion is depreciated from the first to the fifth year, and investment of ₹0.5 billion is depreciated from the second to the sixth year.
• The marginal corporate tax rate is 30 per cent.
• The company must hire 100 software engineers, each earning a salary of ₹2 million in the first year, increasing by 15 per cent annually.
• The working capital requirements are small, amounting to roughly 10 per cent of annual sales by way of credit given to customers. The company gets back the credit given at the end of the project.
• The product is expected to have a life of six years. 

Question

1. Find the operating profit and free cash flows of the company. 

2. Given the project’s rather high COC of 15 per cent, should it invest in the development of the new product?