Question

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)

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