Huffman Systems has forecasted sales for its new home alarm systems to be 61,000
ID: 2629645 • Letter: H
Question
Huffman Systems has forecasted sales for its new home alarm systems to be 61,000 units per year at $38.50 per unit. The cost to produce each unit is expected to be about 42% of the sales price. The new product will have an additional $495,000 fixed costs each year, and the manufacturing equipment will have an initial cost of $2,430,000 and will be depreciated over eight years (straight-line). The company tax rate is 35%. What is the annual operating cash flow for the alarm systems if the projected sales and price per unit are constant over the next eight years? Should Huffman Systems add the new home alarm system to its set of products? The manufacturing equipment will be sold off a the end of the eight years for $210,000, and the cost of capital for this project is 14%.
Explanation / Answer
Output = 61000 units
Statement showing annual cash flows:
Given, cost of capital = 14%
Present value of these operating cash flows for 8 years = ($ 660,759 x 8 years) / (1.14)8 = $ 1,853,080
Terminal value at the end of 8 years = Salvage value = $ 210,000
Present value of such terminal value = $ 210000 / (1.14)8 = $ 73617
Total present value of cash flows = $ (1853080+73617) = $ 1,926,697
Initial Outflow = $ 2,430,000
Therefore, Net present value = Present value of Inflows - Present value of Outflows = $ (1926697 - 2430000)
= - $ 503303
Since, the NPV of the project is negative, it is expected to destroy shareholders' wealth. Therefore, Huffman Systems should not add the new home alarm system to its set of products. (ANSWER)
Particulars Amount ($) Sales 38.50 per unit x 61000 units 2348500 Less: Costs (42% of 38.50) $16.17 x 61000 units 986370 Less: Fixed costs 495000 Less: Depreciation (2430000-210000)/8 277500 Profit before Tax 589630 Less: Tax 35% of $ 589630 206371 Profit after Tax 383259 Add: Depreciation 277500 Operating Cash Flows 660759Related Questions
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