Question

Julian's has spent $47,200 to design a new airline carryon bag. It spent another $56,500 testing various materials for their durability. An additional $75,000 was spent on test marketing to determine both the market demand and color preference. Since the test marketing proved successful, the firm is now compiling data to evaluate the addition of this bag to its production runs. The estimated production start up costs are $932,300 with annual costs thereafter of $57,000. The discount rate is 11 percent and the estimated life of the project is 5 years. What value should be used for the Time 0 cash flow?

Answer 1

Estimated production start up costs of $932,300 should be used for the Time 0 cash flow. it is the initial investment required for start the project and continue production.

design cost of $47,200, testing cost of materials of $56,500 and test marketing cost of $75,000 are sunk cost. they have been already incurred and can't be recovered irrespective of whether production happens or not. so, they should not be used for the Time 0 cash flow.

annual costs of $57,000 should be used for time 1 to 5 cash flow.