Question

Calculate Cash Flows

Daffodil Inc. is planning to invest in manufacturing equipment to make a new garden tool. The new garden tool is expected to generate additional annual sales of 5,100 units at $38.00 each. The new manufacturing equipment will cost $82,800, have a 10-year life, a residual value of $6,300, and will be depreciated using the straight-line method. Selling expenses related to the new product are expected to be 4% of sales revenue. The cost to manufacture the product includes the following on a per-unit basis:

Direct labor		$6.50
Direct materials		21.00
Fixed factory overhead—depreciation		1.50
Variable factory overhead		3.30
	Total	$32.30

a. Determine the net cash flows for the first year of the project, Years 2–9, and for the last year of the project.

Use the minus sign to indicate cash outflows.

			Year 1	Years 2 - 9	Last Year
Operating cash flows:
	Annual revenues		$	$	$
	Selling expenses
	Cost to manufacture
		Net operating cash flows	$	$	$
Initial investment			$
Total for year 1			$
Total for years 2-9				$
	Residual value
Total for last year					$

b. Assume that the operating cash flows occur evenly throughout the year. Determine how many months in the future, from the date of the initial investment, it will be when the cash for the initial investment will be paid back. Round up to the nearest number of months.

Answer 1

a. Determine the net cash flows for the first year of the project, Years 2–9, and for the last year of the project.

	Year 1	Year 2-9	Year 10
Operating cash flows:
Annual revenue	193800	193800	193800
Selling expense	-7752	-7752	-7752
Cost to manufacture	-157080	-157080	-157080
Net operating cash flow	28968	28968	28968
Initial investment	-82800
Total for year 1	53832
Total for year 2-9		231744
Residual value			6300
Total for last year			35268

b) Payback period = 82800/28968 = 2.86 years or 34 months