Question

Hole-in-One Inc. is considering expanding its golf ball business. Each pack of golf balls contains 3 balls. The company has projected the following information:

•Sales of 2,000,000 packs per year at $6 per pack.

•Total costs per pack is $4.

•The project has a 5 year life.

•The required new equipment costs $15,000,000. This equipment will be depreciated straight line to zero over the life of the project. Another firm has made an offer to purchase the equipment at the end of the project for $790,000 after-taxes (i.e., do not adjust this amount for taxes), which the company plans to accept.

•Initial change in net working capital is $1,000,000 and 50% will be recovered in the terminal year.

•The firm’s required rate of return is 8%.

•The firm’s tax rate is 21%.

A What is the Total Cash Flow in Year 5?

B What is the amount of the annual operating cash flow?

Answer 1

Solution:-

Annual operating cash flow before tax= No. of units sold*(selling price per unit - cost per unit) = 2,000,000*($6-$4) = $4,000,000

Annual tax savings on depreciation= Annual depreciation*21% = (15,000,000/5)*21% = $630,000

(B)

Annual operating cash flow after taxes= Annual operating cash flow before tax*(1-tax rate) + tax savings on depreciation = 4,000,000*(1-21%) + 630,000 = $3,790,000

(A)

Total cash flow in Year 5= Annual operating cash flow + slvage value of equipment + recovery of working capital = $3,790,000 + $790,000 + ($1,000,000*50%) = $5,080,000