QR, a major international cosmetics company, is considering investing in the production and sale of facial masks. The market for facial masks is growing rapidly and is expected to continue to grow over the next five years. Market intelligence suggests that the total market size in Year 1 will be 50 million units. The company expects the market size to grow at a rate of 10% per annum. The investment is to be evaluated over a five year life at which point it is expected that product innovations will result in a replacement product.
QR’s estimated market share for each of the next five years after the investment is as follows:
Year 1 20% Year 2 25% Year 3 30% Year 4 30% Year 5 35%
QR has spent $25 million developing the product. Investment of $500 million in a new manufacturing facility will be required at the beginning of Year 1. The manufacturing facility will have an estimated residual value of $120 million at the end of five years. The manufacturing facility will be depreciated using the straight line method. The project will also require an investment in working capital of $30 million at the beginning of the project.
The selling price of the facial mask will be $30 per unit and the variable cost per unit will be $10. The selling price and the variable cost per unit are expected to remain the same throughout the life of the product.
The new manufacturing facility will be used exclusively for the manufacture of facial masks. The total fixed manufacturing costs will be $200 million per year including depreciation. It is anticipated that $50 million per year will be spent in years 1 and 2 and $80 million per year in years 3, 4 and 5 on technical improvements and marketing the new product. Taxation
QR’s Financial Director has provided the following taxation information:
• Tax depreciation: 25% per annum of the reducing balance, with a balancing adjustment in the year of disposal. • Taxation rate: 30% of taxable profits. Half of the tax is payable in the year in which it arises, the balance is paid in the following year. • QR has sufficient taxable profits from other parts of its business to enable the offset of any pre-tax losses. Other information • A cost of capital of 12% per annum is used to evaluate projects of this type. • Ignore inflation.
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