Creative Impulse Has Done Development Work on an Exciting New

question 15

Essay

Creative Impulse has done development work on an exciting new product, Yuppo. To date, it has spent $1,000,000 on research and development and is wondering whether or not to continue the development and eventual production of Yuppo. The work to date has no value except to Creative Impulse for the further development and production of the product.
It is expected that another $400,000 will be incurred in development work over the next year at which time it will be capitalized along with the equipment that will be purchased (one year from today) to produce the new product. The cost of the equipment is estimated at $1,000,000.
Creative Impulse will house the equipment and new production process in an unused warehouse. The unused warehouse could have been rented out at $100,000 per year, but the company had elected to keep it unoccupied until now.
Cash flow before taxes and CCA is estimated at $500,000 per year over the ten years of Yuppo's product life. Working capital requirements necessitated by this new product line will increase by $75,000. Potential salvage value of the Yuppo equipment is $100,000 eleven years from today.
CCA rate: 40%
Tax rate: 39%
Cost of capital: 15%
Should Creative Impulse continue the development and production of Yuppo?

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Definitions:

British Pounds

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