Mousike manufactures portable speakers. The company currently has three portable speaker models on the market, and the sales of three models have been excellent.
Mousike’s management is currently pursuing a growth strategy by expanding its product line. One of the products that the company is considering offering to customer is a wireless headphone. Mousike has spent $850,000 to develop a prototype for the new headphone that include features like Bluetooth connectivity, noise cancellation and a 24 hours battery life. The company has spent a further $300,000 for a marketing study to determine the expected sales
figures for the new headphone.
The project is estimated to last for five years. The estimated sales volume is 6,000, 8,500, 10,000, 12,000 and 9,000 per each of the next five years respectively. The selling price will be set at $300 per unit and is expected to remain constant over the five-year period due to the competitive nature of the industry. The variable cost will be $170 per unit in the first year. Unlike the selling price, the variable cost is expected to increase at 10 percent a year as a result of increasing material cost. Fixed cost for the project will be $100,000 per year and this cost will remain constant over the five-year period.
Furthermore, the company will need to invest a total of $910,000 to purchase the necessary equipment. This $910,000 will be 100 percent depreciated straight line over 7 years.The equipment can be sold for $350,000 at the end of the project.
The project will require Mousike to make an investment in net working capital of $150,000 at the beginning of the project. Subsequently, the net working capital at the end of each year (year 1 to year 4) will be equal to 10 percent of the sales revenue for that year. Mousike has a 40 percent corporate tax rate and the required return of the project is 17 percent.
As previously stated, Mousike currently has three models of portable speakers on the market. The introduction of the new headphone will likely take customers away from the existing portable speakers. Customers who has the intention to purchase the speakers may decide to buy the headphone instead. The company estimates that this will result in a decrease in operation cash flows of $100,000 per year.
Based on the above information, should the company proceed with the project?
