Thirdd Foods is considering producing a new candy, Yum. Thirdd has spent two years and P450,000 developing this product. Thirdd has also test marketed Yum, spending P100,000 to conduct consumer surveys and tests of the product in 25 states. Based on previous candy products and the results in the test marketing, management believes consumers will buy 4 million packages each year for ten years at 50 cents per package. Equipment to produce Yum will cost Thirdd P1,000,000, and P300,000 of additional net working capital will be required to support Yum sales. Thirdd expects production costs to average 60% of Yum’s net revenues, with overhead and sales expenses totaling P525,000 per year. The equipment has a life of ten years, after which time it will have no salvage value. Working capital is assumed to be fully recovered at the end of ten years. Depreciation is straight-line and Thirdd’s tax rate is 45%. The required rate of return for projects of similar risk is 10%. A. What is the initial investment from this project? B. What is the NPV of this investment? Should Thirdd Foods produce this new candy? C. Suppose that competitors are expected to introduce similar candy products to compete with Yum, such that peso sales will drop following the first-year. What is the maximum drop in sales annually from this product for year 2 onwards and still make this a viable investment?
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
Thirdd Foods is considering producing a new candy, Yum. Thirdd has spent two years and P450,000 developing this product. Thirdd has also test marketed Yum, spending P100,000 to conduct consumer surveys and tests of the product in 25 states.
Based on previous candy products and the results in the test marketing, management believes consumers will buy 4 million packages each year for ten years at 50 cents per package. Equipment to produce Yum will cost Thirdd P1,000,000, and P300,000 of additional net working capital will be required to support Yum sales. Thirdd expects production costs to average 60% of Yum’s net revenues, with overhead and sales expenses totaling P525,000 per year. The equipment has a life of ten years, after which time it will have no salvage value. Working capital is assumed to be fully recovered at the end of ten years.
A. What is the initial investment from this project?
B. What is the
C. Suppose that competitors are expected to introduce similar candy products to compete with Yum, such that peso sales will drop following the first-year. What is the maximum drop in sales annually from this product for year 2 onwards and still make this a viable investment?
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