Suppose a company has the opportunity to bring out a new product, the Vitamin-Burger. The initial cost of the assets is $100 million, and the company’s working capital would increase by $10 million during the life of the new product. The new product is estimated to have a useful life of four years, at which time the assets would be sold for $5 million.
Management expects company sales to increase by $220 million the first year, $260 million the second year, $140 million the third year, and then trailing to $50 million by the fourth year because competitors have fully launched competitive products. Operating expenses are expected to be 90% of sales, and depreciation is based on an asset life of straight line depreciation method.
If the required rate of return on the Vitamin-Burger project is 12% and the company’s tax rate is 45%, should the company invest in this new product? Why or why not?