Question

RET Inc. currently has one product, low-priced stoves. RET Inc. has decided to sell a new line of medium-priced stoves. Sales revenues for the new line of stoves are estimated at $20 million a year. Variable costs are 80% of sales. The project is expected to last 10 years. Also, non-variable costs are $2,000,000 per year. The company has spent $3,000,000 in research and a marketing study that determined the company will lose (cannibalization) $4 million in sales a year of its existing low-priced stoves. The production variable cost of the existing low-priced stoves is $2 million a year.

The plant and equipment required for producing the new line of stoves costs $20,000,000 and will be depreciated down to zero over 20 years using straight-line depreciation. It is expected that the plant and equipment can be sold (salvage value) for $12,000,000 at the end of 10 years. The new stoves will also require today an increase in net working capital of $3,000,000 that will be returned at the end of the project.

The tax rate is 30 percent and the cost of capital is 10%.

1. What is the initial outlay (IO) for this project?

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

3. What is the annual net operating profits after taxes (NOPAT) for this project?

4. What is the annual incremental net cash flow (operating cash flow: OCF) for this project?

5. What is the remaining book value for the plant at equipment at the end of the project?

6. What is the cash flow due to tax on salvage value for this
project? Enter a negative # if it is a tax gain. For example, if
your answer is a tax on capital gains of $3,004.80 then enter
**-3,005** ; if your answer is a tax
shelter from a capital loss of $1,000,20 then enter
**1,000**

7. What is the project's cash flow for year 10 for this project?

8. What is the Net Present Value (NPV) for this project?

Answer #1

sales 20 million

variable cost is 80% of sales which is 16 million

depreciation using straight line method is 1 million

Ans 1.

Fixed capital requirement = 20 million

Research cost = 3 million

total cash out lay for the project = 23million

Ans 2.

Annual Earnings before Int and tax = 20 - 16 - 0.8 =3.2 million

Ans 3. Earnings after tax = 3.2 - 2.3(interest)= 0.9 - .36 (tax) = 0.54

ans 4. Operating cash flow = 0.54+ 0.8 = 1.34

Ans 5. Annual depreciation is 1 million/ year

that is total dep for 10 yeras =10 million

there fore book value of plant after 10 years = 20 - 10 =10 million

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