Business case, very easy

I don’t understand this Accounting question and need help to study.

It’s March 31, 2009. Bobby Singer, the Vice-President of Operations for Sam & Dean’s Pest Removal Service is assessing a brilliant new idea which is to launch on January 1, 2010. He wishes to analyze the financial performance of the new product for its first full year in the market (2010) for a meeting with his CEO, John Winchester. Here is what he knows:

  • The total market size is 15 million households.
  • The addressable market for the company’s product in 2010 is 10% of the total market (household penetration rate).
  • Each household in the addressable market will buy 2 units per year.
  • For the first year in the market, a unit market share of 13% is expected.
  • The average selling price is $12.00 per unit in 2010.
  • The variable cost of goods sold is $5.00 per unit.
  • Variable marketing and selling expenses (commissions and broker fees) are projected at 5% of the average selling price.
  • Variable packaging costs are forecasted at $1.85 per unit.
  • Fixed marketing costs are $400,000 per year.
  • Fixed manufacturing costs are $600,000 per year.
  • Fixed G & A (general & admin) expenses are $250,000 per year.
  • The initial investment to launch the product is $6.0 million which will be spent in 2009.

What should Bobby Singer tell his CEO?

It’s now April 2, 2009. Bobby Singer has returned from the meeting with the CEO, John Winchester, to discuss his financial analysis of their potential new product, the Creature Eliminator. John Winchester was very interested in the idea but wanted to see an expanded, more detailed analysis. These are the changes that were discussed during the meeting:

  • The total market size needs to be changed to the correct number of 20 million households
  • The initial market share would be projected at a more conservative 10%
    • The total number of households would grow at 1.5 % per annum after 2010
    • The addressable market would increase by 100 bps each year after 2010
    • The average purchase per household would increase by 0.50 units in 2011, by 0.45 units in 2012, by 0.35 units in 2013 and by 0.30 units in 2014
    • Market share would grow by 100 basis points for 2 years, then decrease by 25 basis points and then fall by 50 basis points in 2014
    • The selling price would increase by 3% per annum after 2010
    • Variable expenses (cogs and variable packaging) are forecasted to increase by 4% annually after 2010
    • Fixed expenses are forecasted to increase by 1% annually after 2010

It was also decided that the analysis would be extended out to cover 5 years. Bobby and John agreed upon the assumptions to include in the projection of results for the years beyond 2010:

  • The initial investment to launch the product is now expected to be $6.86 million
  • The company uses a pre-tax discount rate for Net Present Value calculations of 15% to evaluate new investments
  • The CEO also asked that the spreadsheet be formatted for inclusion in a presentation at an upcoming management meeting.

What should Bobby Singer now tell his CEO?