Question -
Write safe Plc, the makers of indestructible ballpoint pens, have decided to launch a new "budget range" of two designs of pens. Both will contribute £1.40 in profit before promotion and depreciation on the factory.
The factory will cost £1.4 million upfront and £280,000 will be spent in the first year to market the products. It is estimated that the project will have a seven-year lifespan. £84,000 will be spent on marketing per year from year two to year seven. There is a 40% chance that both pens will be a success, in which case 1.4 million will be sold.
If only one of the two is successful then the estimated sales will be 980,000 in year one. There is a 30% chance of this happening. Failure of both models will result in sales of only 700,000 pens.
If both designs are successful in the first year then there are two further possibilities:
a. 1.4 million sold in each of years 2 to 7
b. Only 420,000 are sold in each of the remaining years.
The possibility of each occurring is equal.
If only one design is successful then there is a 40% chance of further sales being 1.12m per year and a 60% chance of sales falling to 560,000 per year.
If both products are unsuccessful then the project will be abandoned with no salvage value.
Assumptions:
- Ignore tax and inflation.
- The company's cost of capital is 8 per cent.
- All amounts, unless otherwise stated, are paid and received at the end of each year.
Required:
a. Using net present value, advice the company on whether or not to continue with the project. Show all numbers in thousands.
b. Calculate the standard deviation of the project.