Financial management unit 4 IP

7 Oct No Comments

Manufacturing company is thinking of launching a new product. The company expects to sell $950,000 of the new product in the first year and $1,500,000 each year thereafter. Direct costs including labor and materials will be 55% of sales. Indirect incremental costs are estimated at $80,000 a year. The project requires a new plant that will cost a total of $1,000,000, which will be a depreciated straight line over the next 5 years. The new line will also require an additional net investment in inventory and receivables in the amount of $200,000.

Assume there is no need for additional investment in building the land for the project. The firm’s marginal tax rate is 35%, and its cost of capital is 10%.


A. Prepare a statement showing the incremental cash flows for this project over an 8-year period.

Year 1 2 3 4 5 6 7 8
Revenue $950,000 $1,500,000 $1,500,000 $1,500,000 $1,500,000 $1,500,000 $1,500,000 $1,500,000
Expenses:                
Direct costs $522,500 $825,000 $825,000 $825,000 $825,000 $825,000 $825,000 $825,000
Indirect incremental costs $80,000 $80,000 $80,000 $80,000 $80,000 $80,000 $80,000 $80,000
Depreciation $200,000 $200,000 $200,000 $200,000 $200,000      
Profit before tax $147,500 $395,000 $395,000 $395,000 $395,000 $595,000 $595,000 $595,000
Tax $51,625 $138,250 $138,250 $138,250 $138,250 $208,250 $208,250 $208,250
Profit after tax $95,875 $256,750 $256,750 $256,750 $256,750 $386,750 $386,750 $386,750
Year 1 2 3 4 5 6 7 8
Profit after tax   $95,875 $256,750 $256,750 $256,750 $256,750 $386,750 $386,750 $386,750
Add:                  
Depreciation   $200,000 $200,000 $200,000 $200,000 $200,000 $0 $0 $0
Initial outlay -$1,000,000                
Additional investment -$200,000                
Net cash flow -$1,200,000 $295,875 $456,750 $456,750 $456,750 $456,750 $386,750 $386,750 $386,750

B. Calculate the payback period (P/B) and the net present value (NPV) for the project.

Year Cash flow Outstanding balance
0 ($1,200,000) ($1,200,000)
1 $295,875 ($904,125)
2 $456,750 ($447,375)
3 $456,750 $9,375
4 $456,750 $466,125
5 $456,750 $922,875
6 $386,750 $1,309,625
7 $386,750 $1,696,375
8 $386,750 $2,083,125
  Payback period 2 Years, 11 Months
Year Cash flow Discount rate Discount factor Discounted cash flow
0 ($1,200,000) 10% 1.00 ($1,200,000)
1 $295,875 10% 1.10 $268,977
2 $456,750 10% 1.21 $377,479
3 $456,750 10% 1.33 $343,163
4 $456,750 10% 1.46 $311,966
5 $456,750 10% 1.61 $283,606
6 $386,750 10% 1.77 $218,310
7 $386,750 10% 1.95 $198,464
8 $386,750 10% 2.14 $180,422
      Net present value $982,388


Answer the following questions based on your P/B and NPV calculations:

1. Do you think the project should be accepted? Why? Assume the company has a P/B (payback) policy of not accepting projects with life of over 3 years.

From the above calculations, you will observe that the net present value is above zero. Under the NPV (net present value) rule a project is acceptable only if its value is above zero. The NPV technique shows the firm what it would earn as “profit” if the project is undertaken.

Also from the P/B calculations, you will observe that the period is below the minimum cut-off period of 3 years.

Essentially under the NPV and P/B basis, the project would have to be accepted.


2. If the project required additional investment in land and building, how would this affect your decision? Explain.

Any additional investments would invariably increase the total initial outlay. This would in turn reduce the payback period and also the net present value determined in the previous sections.




Click following link to download this document

Financial management unit 4 IP.docx

Would you like your assignment done free from plagiarism by an expert? Place your order now and it shall be done within the timeframe you indicate.

To view and download a complete answer, scroll down to the bottom to pay Pay to view