Question

Quick Computing currently sells 10 million computer chips each year at a price of $20 per chip. It is about to introduce a new chip, and it forecasts annual sales of 12 million of these improved chips at a price of $25 each. However, demand for the old chip will decrease, and sales of the old chip are expected to fall to 3 million per year. The old chips cost $6 each to manufacture, and the new ones will cost $8 each. What is the proper cash flow to use to evaluate the present value of the introduction of the new chip?

Answer 1

Answer:

Annual cashflow for the decision= $162  million

Explanation:

The proper cashflow would be determined as follows:

Contribution per unit = Sales price - variable cost

Contribution per unit of new chip  = 25-8 = $17 per unit

Contribution per unit of old chip = 20 - 6 = 14 per unit.

Contribution form the sale of the new chip = contribution per unit × annual sales in unit

=17 × 12  million units = $204  million

lost Contribution from the old  chip = contribution per unit × lost annual sales in unit

Lost contribution  from old chip= $14 × 3 million unit = $42 million

Note that the lost contribution is an opportunity cost occasioned as a result of the introducing the new chip, hence the contribution should be deducted

Annual cashflow for the decision= $204  million -$42 million  = $162  million

Annual cashflow for the decision= $162  million