Question

After spending a year and ?$50 comma 000?, you finally have the design of your new...

After spending a year and ?$50 comma 000?, you finally have the design of your new product ready. In order to start? production, you will need ?$30 comma 000 in raw materials and you will also need to use some existing equipment that? you've fully? depreciated, but which has a market value of ?$100 comma 000. Your colleague notes that the new product could represent 10?% of the? company's overall sales and that 10?% of overhead is ?$60 comma 000. Your tax rate is 40?%. As you start your analysis of the? product, what should be your initial incremental free cash? flow?

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Answer #1

Initial incremental cash flow

Investment in raw material. -$30,000

Market value of machine used. -$100,000

Tax on sale (100000*40%). $40,000

Total initial cash flow. -90000

So initial incremental cash flow is -$90000

note : already spent expenses and overhead allocation are irrelevant. As these are not changed now due to new project.

Machine could be sold for $100000. So this is lost amount and opportunity cost will be considered.

Machine is fully depreciated. So tax payable @40% on sale of $100000 is saved. So this is benefit associated with project

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