Lecture09extra_winter09

# Lecture09extra_winter09 - PROBLEM 40 CHAPTER 7 J. Smythe...

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PROBLEM 40 CHAPTER 7

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J. Smythe manufactures fie furniture. The company is deciding to introduce a new mahogany dining room set. The set will sell for \$5,600. The company feels that sales will be 1,300; 1,325; 1,375; 1,450 and 1,320 per year for the next 5 years. Variable costs amount for 45% of sales and fixed costs are 1.7 million per year. The new table will require inventory amounting to 10% of sales, in the year previous to sales.
It is believed that the addition of the new set will cause a loss of 200 tables per year on the oak tables. These tables sell for \$4,500 and have variable costs of 40%. Needed inventory is also 10% of sales. The company currently has excess production capacity. If the company buys new equipment, it will cost \$10.5 million. However, the excess capacity means the company can produce the new tables with the old equipment for the next two years.

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This means that, if the company uses the old equipment, it will be forced to buy the new equipment, at a cost of \$10.5 million in two years. In five years, the new equipment will be sold at a market value of %2.8 million if bought today or \$6.1 million if bought two years from now. The equipment is depreciated on a 7 year MACRS schedule. The tax rate is 38% and required return is 14%.
Questions Should the project be undertaken? Can you perform IRR analysis to this project? How many IRRs do you expect to find? How would you interpret the profitability index?

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J. Smythe manufactures fine furniture. The company is deciding to introduce a new mahogany dining room set. The set will sell for
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## This note was uploaded on 01/28/2012 for the course ECON 134a taught by Professor Lim during the Winter '08 term at UCSB.

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Lecture09extra_winter09 - PROBLEM 40 CHAPTER 7 J. Smythe...

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