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M.Sc. SHRM / CAPITAL BUDGETING PROBLEM

“TOMATO LIGHT” by “TOMATO WORLD” Inc.

The firm’s management is currently evaluating a new product –“tomato light” juice. After spending $18,000 in marketing research, the firm found that there is a significant part of the market that although likes the tomato, does not consume tomato juice because of its high concentration of sugar. The new product although more expensive than the existing competing brands offers 35 percent less calories with no sugar or other additives. 

Production facilities for the Tomato Light Juice product would be set up in an unused section of the company’s main plant. In case the project is not implemented, this section of the plant will be leased for $15,000 per year. The cost of machinery needed for the project is $200,000. The machinery will be fully depreciated over 4 years, using the straight line depreciation method. The machinery is expected to be sold for scrap for $5,000 after tax after 4 years use. 

The management of the firm believes to sell 40,000, units of the new product in each of the next 4 years, at a price of $4.5 per unit, of which $1.4 would be the total production cost per unit. 

In examining the sales figures, you noted a short memo from the marketing manager expressing his concerns that the Tomato Light product would hurt the sales of the firm’s existing tomato juice. After investigating this matter further you found that indeed the new project would probably reduce the sales of the firm’s regular tomato juice by $30,000 per year, which have a cost to produce $14,000 per year, all on a pre-tax basis. (Hint find the cannibalization cost expected to occur every year).The “Tomato World” has a cost of capital 20% and the corporate tax rate is 40%. 

Calculate the NPV of the above project.

(Before you solve the above problem please read from the main textbook  pages 360-363; page 373; and pages 394-396)