The Jogger Shoe Company is trying to decide whether to make a change in its most popular brand of running shoes. The new style would cost the same to produce and be priced the same, but it would...

The Jogger Shoe Company is trying to decide whether to make a change in its most popular brand of running shoes. The new style would cost the same to produce and be priced the same, but it would incorporate a new kind of lacing system that (according to its marketing research people) would make it more popular. There is a fixed cost of $300,000 for changing over to the new style. The unit contribution to before-tax profit for either style is $8. The tax rate is 35%. Also, because the fixed cost can be depreciated and will therefore affect the after-tax cash flow, we need a depreciation method. We assume it is straight-line depreciation. The current demand for these shoes is 190,000 pairs annually. The company assumes this demand

will continue for the next 3 years if the current style is retained. However, there is uncertainty about demand for the new style, if it is introduced. The company models this uncertainty by assuming a normal distribution in year 1, with mean 220,000 and standard deviation 20,000. The company also assumes that this demand, whatever it is, will remain constant for the next 3 years. However, if demand in year 1 for the new style is sufficiently low, the company can always switch back to the current style and realize an annual demand of 190,000. The company wants a strategy that will maximize the expected NPV of total cash flow for the next 3 years, where a 15% interest rate is used for the purpose of calculating NPV. ■