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)

Homework Answers

Answer #1

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

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