Question

(Estimated time allowance: 12 minutes) Call-Si Corp. currently has two products, high priced cell phones and apps for its cell phones. Call-Si Corp. has decided to sell a new line of low-priced cell phones. Sales revenues for the new line of cell phones are estimated at $2,000 a year and variable costs are $1,500 a year. The project is expected to last 10 years. Also, non-variable costs are $400 per year. The company has spent $100 in a research and a development study that determined the company will have synergy gains/sales of $200 a year from sales of its existing apps for its cell phones but it will lose $500 annual sales of its high-price cell phones. The annual production variable costs are 60% of high-priced cell phone sales and 40% of apps of cell phone sales.

The plant and equipment required for producing the new line of cell phones costs $600 and will be depreciated down to zero over 15 years using straight-line depreciation. It is expected that the plant and equipment can be sold (salvage value) for $300 at the end of 10 years. The new cell phones will also require today an increase in net working capital of $50 that will be returned at the end of the project.

The tax rate is 25 percent and the cost of capital is 12%.

Use the above information to answer the following 3 questions (filling in the blanks). When answering the questions, DO NOT use dollar signs, USE commas to separate thousands, DO NOT use parenthesis to denote negative numbers, USE the negative sign and place it in front of first digit of your answer when your answer is a negative number. Round to the nearest dollar (do not enter decimals). For example, if your answer is -$1,245.80 then enter -1,246

1. What is the annual depreciation of the plant and equipment?

2. What is the annual Earnings before Interests, and Taxes (EBIT) for this project?                                   

3. What is the annual incremental net cash flow (FCF or OCF) for this project?

Answer 1

ANSWER:

1).

The annual depreciation of the plant and equipment is given below :

Annual depreciation = Cost of plant and equipment / Life in years

= 900/15

= $60 / year

.

2).The annual Earnings before Interests, and Taxes (EBIT) for this project is given below :

Annual EBIT = (sales revenue + sales gained due to synergy - sales lost of the high priced phone) - (variable cost of the low priced phone + variable cost due to synergy sales - variable cost of high priced phone) - non-variable cost - annual depreciation

= (2,000 + 100 - 400) - (1,500 + (20%x100) - (50%x400)) - 500 - 60

= 1,700 - 1,320 – 500 – 60

= -$180

.

3).The annual incremental net cash flow (FCF or OCF) for this project :

Annual Net Cash Flow = EBIT x (1-Tax rate) + annual depreciation

= -180 x (1-20%) + 60

= -144 + 60

= -$84