Simtex Ltd has invested £120,000 to date in developing a new type of shaving foam. The shaving foam is now ready for production and it has been estimated that the business will sell 160,000 cans a year of the new product over the next four years. At the end of four years, the product will be discontinued and probably replaced by a new product by Simtext Ltd.
The shaving foam is expected to sell at £6 a can and the variable cost is estimated at £4 per can.
Fixed cost (excluding depreciation) is expected to be £300,000 a year. (This figure includes £130,000 of the existing general overheads of the business that will be apportioned to this new product.)
To manufacture and package the new product, equipment costing £480,000 must be acquired immediately by Simtex LtdThe estimated value of this equipment in four years’ time is £100,000.
The business (Simtex Ltd) calculates depreciation using the straight-line method (equal amounts each year). It has an estimated of 12 per cent.
Required:
(a) D educe the of the new product.
(b) Calculate by how much each of the following must change before the new product is no longer profitable:
1 the discount rate;
2 the initial outlay on new equipment;
3 the net operating cash flows;
4 the residual value of the equipment.
(c) Should the business produce the new product?
