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13 September, 05:07

You have determined that an OCF of $142,098 will result in a zero net present value for a project, which is the minimum requirement for project acceptance. The fixed costs are $418,000 and the contribution margin per unit is $87.20. The company feels that it can realistically capture 4.5 percent of the 120,000 unit market for this product. The required rate of return is 11 percent. Should the company develop the new product

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  1. 13 September, 05:30
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    The company should not develop the new product as The operation cash flow is too low as compared to the OCF that results in zero NPV.

    Explanation:

    In order to know if the company should develop the new product we would have to make the following calculations:

    The No, of units the company expects to sell = Market share*Market size = 4.5%*120,000 = 5,400

    Total contribution = No. of units sold*contribution margin per unit = 5400*87.20 = $470,880

    Fixed costs = $418,000

    Profit before tax = Total contribution - Fixed costs = $470,880 - $418,000 = $52,000

    Net profit = (1-Tax rate) * Profit before tax = (1-34%) * $52,000 = $34,320

    Since there are no depreciation costs (assumed), net profit is the operating cash flow.

    Therefore, the company should not develop the new product as The operation cash flow is too low as compared to the OCF that results in zero NPV.
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