You are entering the widget business. It costs $500,000, payable in year 1, to develop a prototype. This cost can be depreciated on a straight-line basis during years 1–5. Each widget sells for $40 and incurs a variable cost of $20. During year 1, the market size is 100,000, and the market is growing at 10% per year. You believe you will attain a 30% market share. Profits are taxed at 40%, but there are no taxes on negative profits.
a. Given your other assumptions, what market share is needed to ensure a total (FCF) of $0 over years 1 to 5? (FCF during a year equals after-tax profits plus depreciation minus fixed costs, if any.)
b. Explain how an increase in market share changes profit.
c. Explain how an increase in market size growth changes profit.
d. Use Excel’s auditing tool to show how the market growth assumption influences your spreadsheet.
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