Question

REX currently has two products, low and high priced stoves. REX Inc. has decided to sell a new line of medium-priced stoves. Sales revenues for the new line of stoves are estimated at $600 a year. Variable costs are 75% of sales. The project is expected to last 10 years. Also, non-variable costs are $50 per year. The company has spent $10 in research and a marketing study that determined the company will have synergy gains/sales of $30 a year from sales of its existing high-priced stoves. The production variable cost of these sales is $50 a year. The plant and equipment required for producing the new line of stoves costs $900 and will be depreciated down to zero over 20 years using straight-line depreciation. It is expected that the plant and equipment can be sold (salvage value) for $120 at the end of 10 years. The new stoves will also require today an increase in net working capital of $40 that will be returned at the end of the project.

The tax rate is 12 percent and the cost of capital is 35%.

6. What is the cash flow due to tax on salvage value for this project?

7. What is the project's cash flow for year 10 for this project?

Answer 1

6. Cash flow due to tax on salvage value of the project is as below:-

Stove cost = 900 $

Useful life = 20 years

Depreciation for 10 years as per SLM = 900 / 20 * 10 = 450 $

Book Value at end of 10 years = 900 - 450 = 450 $

Salvage value at end of 10 years = 120 $

Thus, Loss on sale of stove = 450 - 120 = 330 $

Tax saved = 12% of 330 $ = 39.6 $

7. Cash flow for year 10 for the project is as follows:-

Sales revenues $600

Variable costs are 75% of 600 = - 450

non-variable costs are - 50

synergy gains/sales of $30 a year from sales of its existing high-priced stoves.

The production variable cost of these sales is - $50

Tax = 12% of [600 - 450 - 50 + 30 - 50 -330 (loss on sale of stove) ] =  18

Return of increase in net working capital of $40

Sale of Stove = 120$

Thus Cash Flow for 10th Year= 600-450-50+30-50+40+120 = 640$