Question

A company manufactures fitness equipment. Two years ago, it conducted a marketing study to collect consumers’ views and perception about a new fitness equipment that they intend to produce. The study cost them $1,000,000. Today, the company is considering introducing a new fitness equipment. The CFO has collected the following information about the proposed product. The project has an anticipated economic life of 4 years, after that it will not be continued and will be terminated. The company will have to purchase a new machine to produce the equipment. The machine has a cost of $1.5 million and requires transportation and installation to the company that will cost additional $600,000. The machine will be depreciated using MACRS 5-year class (20%, 32%, 19.2%, 11.52%, 11.52% and 5.76%). The company anticipates to sell this machine to another manufacturer for $300,000 at the end of four years. If the company goes ahead with the proposed product, it will have an effect on the company’s operating working capital. The inventory will increase by $350,000 and accounts payable will increase by $150,000. The new fitness equipment is expected to generate sales revenue of $1.5 million the first year, $2 million the second year, $2.5 million the third year, and $1.5 million the fourth year. Each year the operating costs (not including depreciation) are expected to equal 35 percent of sales revenue. The company’s interest expense each year will be $800,000. The new fitness equipment is expected to reduce the after-tax cash flows of the company’s existing products by $350,000 a year over the next 4 years. The company’s overall cost of capital is 11 percent. The company’s tax rate is 30 percent. What is CF4? (The cash flow to be used for NPV calculations).

806,360

923,940

1,042,110

754,830

1,086,340

Answer 1