The Bogart Company, originally established 77 years ago to make baseballs, is now a leading producer of tennis balls, baseballs, footballs, and golf balls. Eleven years ago, the company introduced “Speed Flight”, its first line of high-performance tennis balls. Bogart management has sought opportunities in whatever businesses seem to have some potential for extra cash flow. Recently C.W. Grant, vice president of the Bogart Company, identified another segment of the sports ball market that looked promising and that he felt was not adequately served by larger manufacturers. That market was for brightly colored bowling balls, and he believed many bowlers valued appearance and style above performance. He also believed that it would be difficult for competition to take advantage of the opportunity because of both Bogart’s cost advantages and its highly developed marketing skills.
As a result, the Bogart Company investigated the marketing potential of brightly colored bowling balls. Bogart sent a questionnaire to consumers in the three markets: Boston, San Francisco, and Myrtle Beach. The results of the three questionnaires were much better than expected and supported the conclusion that the brightly colored bowling balls could achieve an 11 to 17 percent share of the market. Of course, some people at Bogart complained about the cost of the test marketing, which was $250,000. In any case, the Bogart Company is now considering investing in a machine to produce bowling balls. The bowling balls would be manufactured in a building owned by the firm and located near Los Angeles. This building, which is vacant, and the land can be sold for $350,000 after taxes. The value of the building is not expected to change for at least 10 years.
In any case, the Bogart Company is now considering investing in a machine to produce bowling balls. The bowling balls would be manufactured in a building owned by the firm and located near Los Angeles. This building, which is vacant, and the land can be sold for $350,000 after taxes. The value of the building is not expected to change for at least 10 years. In any case, the Bogart Company is now considering investing in a machine to produce bowling balls. The bowling balls would be manufactured in a building owned by the firm and located near Los Angeles. This building, which is vacant, and the land can be sold for $350,000 after taxes. The value of the building is not expected to change for at least 10 years.
Working with his staff, Grant is preparing an analysis of the proposed new product. He summarizes his assumptions as follows: The cost of the bowling ball machine is $180,000 and it is has an expected life of seven years. At the end of six years, the machine can be sold at a price estimated to be $33,000. Production by year during the next six years is expected to be as follows: 5,000 units, 8,000 units, 12,000 units, 10,000 units, 7,000 and 6,000 units. The price of bowling balls in the first year will be $32. The bowling ball market is highly competitive, so Grant believes that the price of bowling balls will increase at only 2.5% per year. Conversely, the plastic used to produce bowling balls is rapidly becoming more expensive. Because of this, production cash outflows are expected to grow at 11% per year. Firstyear production costs will be $14 per unit. Grant has determined, based on Bogart’s taxable income, that the appropriate tax rate on the bowling ball project is 34%.
Bogart will purchase raw materials before production and sale, giving rise to an investment in inventory. Management determines that an initial investment in net working capital of $12,000 is required. Subsequently, net working capital at the end of each year will be equal to 10% of sales for that year. Investors in Bogart Company require a rate of return of 10%.
1. Calculate the projected cash flows from this project, including pro forma income statements.
2. For this project, calculate:
a. NPV
b. Payback Period
c. Profitability Index
3. Should the company accept or reject this project?