Pescados is a Chilean manufacturer with operations in the UK, well- known for its fishing equipment. Pescados
Question:
Pescados is a Chilean manufacturer with operations in the UK, well- known for its fishing equipment. Pescados considers developing a new product named Tuna. The company commissioned a feasibility study from a consultancy firm at a cost of £30,000. The projected revenues and costs associated with launching the new product are as follows:
Pescados will be selling 20,000 units per year at a price of £160 per unit during four years. Pescados will be discontinuing the product at the end of the 4th year. The cost is £30 per unit. The new product is aimed at a different market niche, such that no cannibalisation with existing products is expected to occur.
They estimate an annual Selling, general and administrative overhead costs (SG&A) of £1,000,000 to market the product.
Pescados needs to make an initial investment of £2,000,000 in a new machine in year 0. The new machine has no recovery (salvage) value and fully depreciates by 25% per year for 4 years (hint: the problem starts in year 0 with the investment in the machine, sales start in year 1 and end in year 4).
The machine will be installed in a warehouse owned by the firm, that could be otherwise rented out by £200,000 per year in case the company chooses not to launch the new product (hint: lost rent is an opportunity cost affecting SG&A).
Working capital requirements: Pescados estimates that customers pay on average within 73 days, whereas Pescados can pay back their suppliers within 73 days too. They do not anticipate any cash nor inventory requirements. (Hint: Working capital will be required in year 1 and will be recovered later in year 4).
Pescados intends to finance the project fully with equity (raised in the UK). The cost of equity capital is 11%.
The corporate tax rate is 35%.
(a) Estimate the project's Net Present Value (NPV). Should this project be accepted or rejected? Justify your answer.
Fundamentals of Financial Accounting
ISBN: 978-0078025914
5th edition
Authors: Fred Phillips, Robert Libby, Patricia Libby