Answered: The selling price will be maintained at…

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Transcribed Image Text:Hardy Limited has undertaken research into launching a new product which will take it into a new market area. Hardy feels it has expanded its existing operation to its maximum potential, and it is the market leader in its existing field. The proposed new product would offer new opportunities and, although there is strong competition in its field already, the management feel it can use its existing brand name to break into this product line. The new product is in car cleaning accessories, but will offer items in a single package not currently available. The management believe that,although the proposed product may be relatively short lived, the penetration of new markets is worthwhile as long as the product does not make a loss. Details of the project are as follows: • Market research costs incurred to date amount to £250,000 • Investment in plant at the start: £2,900,000. At the end of the product's life the plant will have a disposal value of £80,000 . The project is estimated to have a life of 5 years ● The sales price of each unit is initially forecast at £25. • The production cost is £13 per unit including a depreciation charge of £3 per unit • Selling and distribution costs are estimated to be £3 per unit • An initial injection of additional working capital of £100,000 will be needed and should be recoverable in full at the end of the product's life. Estimated sales volumes: Advertising costs: Year 1 Year 2 Year 3 Year 4 Year 5 Year 1 Year 2 100,000 150,000 £200,000 £250,000 £100,000 £150,000 £100,000 Year 3 Year 4 200,000 100,000 Sales volumes (units) To maintain sales, advertising will have to be undertaken throughout the life of the project as follows: Year 5 50,000 The selling price will be maintained at £25 for the first two years and will decrease to £20 in year 3 and to £18 in year 4 and £15 in year 5. Hardy estimates that, as a result of the project, additional administration costs of £100,000 per annum will be incurred and additional maintenance costs of £150,000 in year 4 and £200,000 in year 5. These are in addition to the costs given above. Hardy Limited currently has a cost of capital of 7%. Assume all cash flows occur at year ends except for the purchase of plant and additional working capital which occur at the start of the project. Required: Evaluate the project using NPV method and recommend the company on launching the product.

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