The sales and finance team of a car company is evaluating a new proposed luxury model of its brand that will require an investment of $1Billion in a new machine for car interior decoration.
Demand for the company’s car is expected to begin at 100,000 units in year 1, with 10% annual
growth thereafter. Production cost will be $35,000 per unit in the first year, and increase by a rate
of either 3% or 5% per year as a result of wage increase. Selling price will start at $37,000 and
increase by 4% of the production cost. The model will be phased out at the end of year 10. In
addition, 0.3%, 2% and 1.5% of before tax profit per year will be spent on social corporate
responsibility, commercial (including promotions) and recalls respectively. Assume taxes will be
30% of yearly profit and that inflation will remain at 0% per year throughout the 10 year of
production. Also assume interest rate is expected to be 3% per year in the first 5 years and 5% in
the last 5 years.
a. Based on present worth analysis, is the proposed investment profitable if production cost
increases by a rate of 3% per year as a result of wage increase? Justify your answer. (15 marks)
b. Based on present worth analysis, is the proposed investment profitable if production cost
increases by a rate of 5% per year as a result of wage increase? Justify your answer. (15 marks)