Q.1. One of the company’s technology patents is about to expire, including a likely rush of product entries from the competition. Currently, the product line is projected to have a stagnant sales of 1 million units for the next seven years from 2008 to 2015. The unit price is expected to decrease slightly by 1 percent per year during the same period. The profitability of this product is estimated to be $1,166,000 in 2008, as indicated is the following table.
Simplified Income Statement
Tax at 40 percent
Both the cost of goods sold (CGS) and SG&A expenses are expected to increase by 3 percent per year from 2008 to 2014. The depreciation charge is estimated to remain constant at $1 million per year, and there is salvage value for the equipment at the end of 2014. If the product is continued as planned, the company can recover a working capital of $3.9 Million at the end of 2014 from sales of residual inventory and collection of accounts receivable after having discharged all applicable short-term liabilities. If the management decide to discontinue this product line at the end of 2007, then it can sell the fixed assets related to the product line (having a book value of $7 million) for about $3 million, and the loss of $4 million would be tax deductible. Furthermore, the company can recover the working capital (inventory plus accounts receivable, minus accounts payable and other expenses) worth about $3.9 million at the end of 2007. Assuming that the appropriate discount rate is 12 percent, would you recommend that this product line be discontinued at the end of 2007 or be continued through 2014?
(25-Marks) What is the next best alternative open to the company, besides either shutting it down immediately at the end of 1997 or continuing to run it...
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