NO.4
SMOOTHDRIVE TYRE LTD
Smoothdrive Tyre Ltd manufacturers tyres under the brand name “Super Tread’ for the domestic car market. It is presently using 7 machines acquired 3 years ago at a cost of Rs. 15 lakh each having a useful life of 7 years, with no salvage value.
After extensive research and development, Smoothdrive Tyre Ltd has recently developed a new tyre, the ‘Hyper Tread’ and must decide whether to make the investments necessary to produce and market the Hyper Tread. The Hyper Tread would be ideal for drivers doing a large amount of wet weather and off road driving in addition to normal highway usage. The research and development costs so far total Rs. 1,00,00,000. The Hyper Tread would be put on the market beginning this year and Smoothdrive Tyrs expects it to stay on the market for a total of three years. Test marketing costing Rs. 50,00,000, shows that there is significant market for a Hyper Tread type tyre.
As a financial analyst at Smoothdrive Tyre, Mr. Mani asked by the Chief Financial Officer (CFO), Mr. Tyrewala to evaluate the Hyper-Tread project and to provide a recommendation or whether or not to proceed with the investment. He has been informed that all previous investments in the Hyper Tread project are sunk costs are only future cash flows should be considered. Except for the initial investments, which occur immediately, assume all cash flows occur at the year-end.
Smoothedrive Tyre must initially invest Rs. 72,00,00,000 in production equipments to make the Hyper Tread. They would be depreciated at a rate of 25 per cent as per the written down value (WDV) method for tax purposes. The new production equipments will allow the company to follow flexible manufacturing technique, that is both the brands of tyres can be ...