Bent Creek Company is considering launching a product line extension - a "new and improved" version with enhanced product features and environmentally friendly packaging.
Below are key estimates and assumptions associated with the project:
Project life (in years) 4
Initial cost of equipment $ 2,300,000
Initial Increase in Inventory $ 50,000
Initial Increase in accounts receivables $ 120,000
Initial Increase in accounts payables $ 30,000
Gross sales from the new product line in year 1 $ 1,500,000
Gross sales increase after year 1 (per year) 7%
Operating costs excluding cost of launching (as a% of gross sales) 25%
Launch costs in year 1 $ 75,000
Market research cost prior to the start of the project $ 60,000
Inflation estimate per year (included in sales) 3%
Weighted average cost of capital 12%
Marginal corporate income tax rate 35%
Net working capital will be 10% of sales starting year 1. The new equipment is depreciated on a straight line basis over the life of the project. It is estimated that the new product will result in cannibalization of existing sales by an amount of $75,000 per year. The new equipment is estimated to have a salvage value of $150,000 in 4 years.
Create a spreadsheet solution to this problem and answer the following questions.
1) Using the above information (base case scenario), calculate the criteria needed to determine the project feasibility; Payback, NPV, IRR, MIRR, PI.
2) Based on the above feasibility analysis, would you recommend the new product line extension? Why?