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  XYZ Limited manufactures medical products

Management

 

XYZ Limited manufactures medical products. The company is considering adding a new product
(“Product X”) to its mix but the market for this product is thought to be riskier than the company’s
current operations. However, the Board of Directors is particularly interested in the product because
it has characteristics that meet their aim to become a more environmentally responsible business.
Having already spent significant funds ($1 million) on research and development of the product, the
company is now close to the final investment decision stage and the CEO has asked you to put together
the financial analysis of the project. You will submit a summary of your analysis, along with your
recommendations on the project, in a short memo.
A market research report commissioned by XYZ recommends producing and selling Product X for five
years as technological change will likely render the product obsolete after that time. Estimated annual
sales revenues for Product X in the first three years are expected to be $180 million. For each of years
4 and 5, sales revenues are expected to fall 30% on the prior year. The market research report stressed
Assessment 4: Case Study 2 ACC91210 SP4 2020
2
that the expected fall in revenue is subject to competition and technological advances and their
estimated 30% fall has a high standard deviation.
The product development team has estimated the following operating costs and net working capital
requirements associated with the project. Cost of goods sold is expected to equal 60% of sales
revenues. Selling, general and administrative expenses directly related to the project (excluding
depreciation) are expected to be $12 million in the first year and increase by 3% per year thereafter.
It is also expected that the project will require an amount of net working capital on hand equal to 20%
of each upcoming year’s sales revenue forecast. The investment in working capital will be fully
recovered by the end year 5 as the project winds down.

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