needed by Sunday afternoon. A manufacturing company is thinking of launching a n
ID: 2629789 • Letter: N
Question
needed by Sunday afternoon. A 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 45% of sales. Indirect incremental costs are estimated at $95,000 a year. The project requires a new plant that will cost a total of $1,500,000, 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%. To receive full credit on this assignment, please show all work, including formulae and calculations used to arrive at financial values. Assignment Guidelines: Using the information in the assignment description: Prepare a statement showing the incremental cash flows for this project over an 8-year period. Calculate the payback period (P/B) and the net present value (NPV) for the project. Answer the following questions based on your P/B and NPV calculations: 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. If the project required additional investment in land and building, how would this affect your decision? Explain. Your submitted assignment (125 points) must include the following: A double-spaced Word document of 2
Explanation / Answer
Incremental Cash flow
Year
Revenues
Indirect cost
Direct cost
Cash profit
Depreciation
EBT
tax
EAT
Cash flow
1
950000
95000
427500
427500
300000
127500
44625
82875
382875
2
1500000
95000
675000
730000
300000
430000
150500
279500
579500
3
1500000
95000
675000
730000
300000
430000
150500
279500
579500
4
1500000
95000
675000
730000
300000
430000
150500
279500
579500
5
1500000
95000
675000
730000
300000
430000
150500
279500
579500
6
1500000
95000
675000
730000
730000
255500
474500
474500
7
1500000
95000
675000
730000
730000
255500
474500
474500
8
1500000
95000
675000
730000
730000
255500
474500
474500
The incremental cash flow has been calculated for each year by deducting direct cost and indirect cost to arrive at cash profit, then depreciation is deducted to arrive at earnings before taxes, the tax has been calculated on this earnings @35, then tax has been deducted from EBT to arrive at earnings after taxes, then depreciation has been added back to arrive at incremental cash flow for each year.
Payback Period
Year
Cash flows
Cumulative CF
Year/fraction
1
382875
382875
1
2
579500
962375
1
3
579500
1541875
1
4
579500
158125/579500
0.27
5
579500
3.27
years
The payback period has been calculated by finding the cumulative cash flow by adding each year cash flow to arrive at the figure of initial investment of $1700000. Till year thee the amount is 1541875, which is short by 158125 which will be covered in the fourth year, but not complete year 4, therefore 158125 has been divided by the total cash flow of the year, which gives a fraction of 0.27, it means that total recovery period is 3.27 years.
Net Present Value
Year
Cash flows
PVIF
PV
1
382875
0.9091
348068
2
579500
0.8264
478926
3
579500
0.7513
435387
4
579500
0.6830
395806
5
579500
0.6209
359824
6
474500
0.5645
267843
7
474500
0.5132
243494
8
674500
0.4665
314659
PV of inflows
2844007
less Outflow
-1700000
NPV
1144007
The present value of all years cash flow has been calculated by using discount factor of 10% and using the formula for present value interest factor which is 1/1+r^n. Then the present values of all years have been added and then the initial investment has been deducted to arrive at the NPV, which is positive. The working capital of $200000 has been added at the end of year 8 as it will be recovered in the last year.
The project should be accepted as the NPV is positive by big margin, even if the payback period is slightly higher than the company target period of 3 years, it should be accepted, as the final decision is to be based on NPV, not on the basis of payback period. As the payback period does not consider the cash flow after the payback period.
Any investment in land and building would have lowered the NPV by that amount, if suppose the investment would be $300000, the NPV would be 1144007-300000 = 844007, still the project is acceptable. Any amount of investment in land and building for more than 1144007 would have changed the decision as the NPV would become zero or negative.
Incremental Cash flow
Year
Revenues
Indirect cost
Direct cost
Cash profit
Depreciation
EBT
tax
EAT
Cash flow
1
950000
95000
427500
427500
300000
127500
44625
82875
382875
2
1500000
95000
675000
730000
300000
430000
150500
279500
579500
3
1500000
95000
675000
730000
300000
430000
150500
279500
579500
4
1500000
95000
675000
730000
300000
430000
150500
279500
579500
5
1500000
95000
675000
730000
300000
430000
150500
279500
579500
6
1500000
95000
675000
730000
730000
255500
474500
474500
7
1500000
95000
675000
730000
730000
255500
474500
474500
8
1500000
95000
675000
730000
730000
255500
474500
474500
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