Question

P11–23 Relevant cash flows for a marketing campaign Marcus Tube, a manufacturer of
high-quality aluminum tubing, has maintained stable sales and profits over the past
10 years. Although the market for aluminum tubing has been expanding by 3% per
year, Marcus has been unsuccessful in sharing this growth. To increase its sales, the
firm is considering an aggressive marketing campaign that centers on regularly running
ads in all relevant trade journals and web sites and exhibiting products at all
major regional and national trade shows. The campaign is expected to require an
annual tax-deductible expenditure of $150,000 over the next 5 years. Sales revenue,
as shown in the accompanying income statement for 2015, totaled $20,000,000. If
the proposed marketing campaign is not initiated, sales are expected to remain at
this level in each of the next 5 years, 2016 through 2020. With the marketing campaign, sales are expected to rise to the levels shown in the accompanying table
for each of the next 5 years; cost of goods sold is expected to remain at 80% of
sales; general and administrative expense (exclusive of any marketing campaign outlays)
is expected to remain at 10% of sales; and annual depreciation expense is expected
to remain at $500,000. Assuming a 40% tax rate, find the relevant cash
flows over the next 5 years associated with the proposed marketing campaign.
Sales revenue $20,000,000
Less: Cost of goods sold (80%) 16,000,000
Gross profits $ 4,000,000
Less: Operating expenses
General and administrative expense (10%) $ 2,000,000
Depreciation expense 500,000
Total operating expense $ 2,500,000
Earnings before interest and taxes $ 1,500,000
Less: Taxes (rate 5 40%) 600,000
Net operating profit after taxes 900,000
Marcus Tube Income Statement for
the Year Ended December 31, 2015
Year Sales revenue
2016 $20,500,000
2017 21,000,000
2018 21,500,000
2019 22,500,000
2020 23,500,000
Marcus Tube Sales
Forecast

Answer 1

	2015	2016	2017	2018	2019	2020
Sales	20000000	20500000	21000000	21500000	22500000	23500000
Increase in sales over 2015		500000	1000000	1500000	2500000	3500000
Incremental COGS at 80%		400000	800000	1200000	2000000	2800000
Incremental gross profit		100000	200000	300000	500000	700000
Incremental G&A Expenses at 10%		50000	100000	150000	250000	350000
Advertising campaign expenditure		150000	150000	150000	150000	150000
Incremental EBIT		-100000	-50000	0	100000	200000
Tax at 40%		-40000	-20000	0	40000	80000
Incremental OCF-Relevant cash flows		-60000	-30000	0	60000	120000