Chapter 8 Case Study

Chapter 8 Case Assignment 

Englewood Company has an opportunity to produce and sell a revolutionary new smoke detector

for homes. To determine whether this would be a profitable venture, the company has gathered the

following data on probable costs and market potential:

a. New equipment would have to be acquired to produce the smoke detector. The equipment

would cost $100,000 and be useable for 12 years. After 12 years, it would have a salvage

value equal to 10% of the original cost.

b. Production and sales of the smoke detector would require a working capital investment of

$40,000 to finance accounts receivable, inventories, and day-to-day cash needs. This

working capital would be released for use elsewhere after 12 years.

c. An extensive marketing study projects sales in units over the next 12 years as follows:

Year         Sales in Units

1……………. 4,000

2……………. 7,000

3……………. 10,000

4-12………… 12,000

d. The smoke detectors would sell for $45 each; variable costs for production, administration,

and sales would be $25 per unit.

e. To gain entry into the market, the company would have to advertise heavily in the early

years of sales. The advertising program follows:

Amount of Yearly

Year             Advertising

1-2…………. $70,000

3…………… $50,000

4-12……….. $40,000

f. Other fixed costs for salaries, insurance, maintenance, and straight-line depreciation on

equipment would total $127,500 per year. (Depreciation is based on cost less salvage

value.)

g. The company’s required rate of return and tax rate are both 20%.

Required:

1. (6 points) Compute the net cash inflow (cash receipts less yearly cash operating expenses)

anticipated from the sale of the smoke detectors for each year over the next 12 years.

2. (4 points) Using the data computed in (1) above and other data provided in the problem,

determine the net present value of the proposed investment. Would you recommend that

Englewood Company accept the smoke detector as a new product?

Case Guidelines:

Cases have no word-count requirement. Simply answer the questions for each case. 

Your work must be shown within your solution in order to receive credit for calculations--final numeric answers alone are insufficient. 

Each student is allowed only 1 submission--make sure your case is complete before submission.

Handwritten solutions are not acceptable. Solutions must be word-processed to receive credit. I prefer Excel or Word documents, but pdf files are acceptable. Do not worry if your Excel or Word document gets distorted in the Blackboard "pre-view" of your submission. The Blackboard word processor is not very powerful. As long as you attach your actual file, I can open it and review your work as you intended it to be submitted. 

When using intermediate decimal calculations which require rounding, please use this rule for maximum accuracy of your final answer: intermediate calculations should be rounded to as many decimal places as there are digits in your underlying data. For example, if your data is in the ten millions (10,000,000) you should round intermediate calculations to eight decimal places. If your data is in the ten thousands (10,000) you should round intermediate calculations to 5 decimal places.

Final answers should be rounded to the nearest cent (if the answer does not come out as an even dollar amount).

The importance of proper rounding using the intermediate calculation rule is illustrated in the following example:

40,000,000 X 1/3 = ?

If you round 1/3 to two decimal places, you will get 40,000,000 X .33 = 13,200,000

If you round 1/3 to 8 decimal places (per the above rule), you will get 40,000,000 X .33333333 = 13,333,333

If you do not round properly, your final answer will be off by 133,333

Case Hint:

To help make sure you get off to a good start on the Chapter 8 Case, here is a hint:

The case may be approached in two ways:

 Treat Req. 1 and Req. 2 independently. For Req. 1 Calculate the yearly cash flows (including tax effects) from only the sales of smoke detectors. For Req. 2 Determine the present values of your results from Req. 1 and combine those present values with the present values of the remaining cash flow items in the case to determine NPV.

Treat Req. 1 and Req. 2 together as a part of a "big picture" approach. To do this, construct a spreadsheet similar to Exhibit 8.2 on page 276 which incorporates all the cash flow items mentioned in the case. This is the approach I would recommend.

If you use the second approach and build a spreadsheet patterned after Exhibit 8.2, please pay careful attention to the calculations illustrated in footnote "b" and footnote "c".