Solved: Perot Corporation is developing a new CPU chip

based on

Perot Corporation is developing a new CPU chip based on a new type of technology. Its new
chip, the Patay2 chip, will take two years to develop. However, because other chip
manufacturers will be able to copy the technology, it will have a market life of two years after it is
introduced. Perot expects to be able to price the chip higher in the first year, and it anticipates a
significant production cost reduction after the first year as well. The relevant information for
developing and selling the Patay2 is given below.

Patay2 Chip Product Estimates

Development Cost ........ $ 20,000,000
Pilot Testing............ $ 5,000,000
Debug.............. $ 3,000,000
Ramp- up Cost........... $ 3,000,000
Advance Marketing........ $ 5,000,000
Marketing and Support Cost..... $ 1,000,000 per year
Unit Production Cost Year 1 .... $ 655.00
Unit Production Cost Year 2.... $ 545.00
Unit Price Year 1 ......... $ 820.00
Unit Price Year 2.......... $ 650.00
Sales and Production Volume Year 1 ...... 250,000
Sales and Production Volume Year 2 ..... 150,000
Interest Rate.............. 10%

a. What are the yearly cash flows and their present value (discounted at 10 percent) of this
project? What is the net present value?
b. Perot’s engineers have determined that spending $ 10 million more on development will
allow them to add even more advanced features. Having a more advanced chip will allow them
to price the chip $ 50 higher in both years ($ 870 for year 1 and $ 700 for year 2). Is it worth the
additional investment?
c. If sales are only 200,000 the first year and 100,000 the second year, would Perot still do
theproject?

ANSWER
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