Margan Inc. (MI) is an online retailer that is relatively successful in saxophone mouthpieces. MI is reviewing the launch of its newly-designed mouthpiece, the ‘Old-Jazz’, which is expected to be of performance grade. The existing machine to manufacture the mouthpiece cost MI $400,000 six years ago. The machine has no resale value. MI just engaged an acoustic expert to assess an upgrade of its machine at a purchase cost of $700,000.

The expert quoted a service fee of $50,000. She estimates that there will be more public performances due to the relaxation of COVID-19 pandemic guidelines. Hence, MI’s future sales are expected to rise, and production costs will decline depending on the state of the economy. The average state is the most likely outcome. Below is a summary of the forecasts.

Sate of economy	Worst	Average	Best
Increase in unit sales	40,000	70,000	100,000
Savings in unit production cost ($)	3	4	7
Life of the upgrade (years)	8	6	4

The company’s cost of capital is 8 percent. Assume MI enjoys a tax holiday for the production of this product.

Required:

1. Compute the net present value of the upgrade for each state of the economy.
2. Conduct a sensitivity analysis on the upgrade. Use the average state as the base case.
3. Make a reasoned recommendation if the upgrade should proceed, and suggest further investigations to improve the quality of the recommendation.

Note: To show all workings with accompanying explanations.

Answer rating: 100% (QA)

Net Present Value for each state of the Economy Worst Net Present Value Investment Costs Present Val... View the full answer