Question

# ABCD Inc. manufactures financial calculators. The company is deciding whether to introduce a new calculator. This...

ABCD Inc. manufactures financial calculators. The company is deciding whether to introduce a new calculator. This calculator will sell for \$100. The company feels that sales will be 12,500, 13,000, 14,000, 13,200, and 12,500 units per year for the next 5 years. Variable costs will be 25% of sales, and fixed costs are \$300,000 per year. The firm hired a marketing team to analyze the viability of the product and the marketing analysis cost \$1,500,000. The company plans to use a vacant warehouse to manufacture and store the calculators. Based on a recent appraisal the warehouse and the property is worth \$2.5 million on an after-tax basis. If the company does not sell the property today then it will sell the property 5 years from today at the currently appraised value. This project will require an injection of net working capital at the onset of the project in the amount of \$100,000. This networking capital will be fully recovered at the end of the project. The firm will need to purchase some equipment in the amount of \$1,200,000 to produce the new calculators. The machine has a 7-year life and will be depreciated using the straight-line method. At the end of the project, the anticipated market value of the machine is \$150,000. The firm requires a 10% return on its investment and has a tax rate of 21%.

Calculate the operating cash flows at the end of year 1 (Round to two decimals)

Calculate the initial cash outflow ( the time 0 cash flow, enter a negative value and round to two decimals)

Part 1

Calculation of Operating Cash Flow of First Year

 Particular Amount in \$ Sale in Units 12500 units Selling Price per Unit \$100 Total Sales \$1250000 Less : Variable Costs @25% (\$312500) Fixed Costs (\$300000) Marketing Cost ((\$1500000/5) (\$300000) Earnings Before Depreciation and Taxes \$337500 Less Depreciation (1200000-750000)/7 \$150000 Earnings Before Taxes \$187500 Less : Taxes @21% \$39375 Earnings after Taxes \$ 148125 Add: Depreciation \$150000 Operating Cash Flows \$298125 PVF @ 10% 0.90909 PV of First Year Cash Flows \$271022.46

Notes

• Marketing cost is assumed to be allowed as deductible expense over the life of the project i.e. 5 years. So 1/5 of this is allowed every year.
• Cost of Warehouse being a sunk cost is ignored
• Since the question asked only first year cash flows, only it is covered.
• Depreciation is as per straight line method.

Part 2

Calculation of Initial Cash Outflow

 Particular Amount in \$ Cost of the Machine \$1200000 Working Capital Invested \$100000 Initial Cash Flow \$1300000