An engineer has an idea for a new product. To get the product to market will require an investment of $575,000. Salvage is expected to be 0, and the investment is expected to last 10 years. The investment qualifies for a 7 year life under the MACRS system of depreciation. Annual operating and maintenance costs are expected to be $25,000 before any increases. The investment also qualifies for a tax credit of 10%.This tax credit will not decrease the depreciable base. Required:
The engineer believes the product will sell for $35.00. The expected annual demand is believed to be 7000. It is thought that the annual price increase for the product will be 2.3%. Labor and material expenses are expected to be $10.00 per unit. It is expected that these costs will increase 3% each year. Maintenance expenses are also expected to increase by 3% each year. Financing will be 78% through shareholders and 22% debt through a bank loan at 8.75% per year. The debt will be repaid through equal annual payments. The tax rate is 40%.

a. Assume the investors want to earn a 10% after tax return. Use the AEC equation to determine how many units need to be sold per year to earn this return. Construct a spreadsheet and use solver to verify the amount calculated for both the standard A/P loan repayment schedule, and for the motorhome debt repayment schedule which keeps the debt ratio constant. Also calculate the net income and the earnings per share, assuming shares were initially issued at $10 per share.
b. Assume the first cost is expensed. Redo part A.