A new production process is being developed that would require an investment of

ID: 2653925 • Letter: A

Question

A new production process is being developed that would require an investment of $1,200,000. Company policy is to depreciate this type of proposal investments using straight-line depreciation over three years. An income statement is shown below. Only the working capital items of inventory, accounts payable, and accounts receivable will be affected by this proposal. The project proposal for the new product will require a buildup of $50,000 of inventory in year 0 before sales are started in year 1. Inventory is expected to be maintained at $50,000 in year 2, reduced to $30,000 in year 2 and $25,000 in year 3. Accounts payable will increase by $20,000 in year 0, continue at $20,000 in year 1, and will diminish to $18,000 in year 2, and to $15,000 in year 3. Accounts receivable will be $0 in year 0 and in years 1-3, it will be 20% of the revenue in that year . The ending value of assets created by the proposal is to be limited to the increase in working capital over the time span of the proposal. That is, there is no salvage value, etc. The working capital gain or loss should not be considered taxable. Prepare a Cash flow statement and evaluate the proposal using a MARR of 15%. Investment $1,200,000 MARR 15% Income Statement 0 1 2 3 Revenue $500,000 $575,000 $850,000 COGS ($200,000) ($230,000) ($340,000) Gross Margin $300,000 $345,000 $510,000 SG&A ($75,000) ($75,000) ($75,000) Depreciation ($400,000) ($400,000) ($400,000) EBIT ($175,000) ($130,000) $35,000 Taxes $35,000 $26,000 ($7,000) Net Income ($140,000) ($104,000) $28,000 A new production process is being developed that would require an investment of $1,200,000. Company policy is to depreciate this type of proposal investments using straight-line depreciation over three years. An income statement is shown below. Only the working capital items of inventory, accounts payable, and accounts receivable will be affected by this proposal. The project proposal for the new product will require a buildup of $50,000 of inventory in year 0 before sales are started in year 1. Inventory is expected to be maintained at $50,000 in year 2, reduced to $30,000 in year 2 and $25,000 in year 3. Accounts payable will increase by $20,000 in year 0, continue at $20,000 in year 1, and will diminish to $18,000 in year 2, and to $15,000 in year 3. Accounts receivable will be $0 in year 0 and in years 1-3, it will be 20% of the revenue in that year . The ending value of assets created by the proposal is to be limited to the increase in working capital over the time span of the proposal. That is, there is no salvage value, etc. The working capital gain or loss should not be considered taxable. Prepare a Cash flow statement and evaluate the proposal using a MARR of 15%. Investment $1,200,000 MARR 15% Income Statement 0 1 2 3 Revenue $500,000 $575,000 $850,000 COGS ($200,000) ($230,000) ($340,000) Gross Margin $300,000 $345,000 $510,000 SG&A ($75,000) ($75,000) ($75,000) Depreciation ($400,000) ($400,000) ($400,000) EBIT ($175,000) ($130,000) $35,000 Taxes $35,000 $26,000 ($7,000) Net Income ($140,000) ($104,000) $28,000

Explanation / Answer

Answer:

Cash flow statement

Revenue

$ 500,000.00

$ 575,000.00

$ 850,000.00

COGS

$ (200,000.00)

$ (230,000.00)

$ (340,000.00)

Gross Margin

$ 300,000.00

$ 345,000.00

$ 510,000.00

SG&A

$ (75,000.00)

Depreciation

$ (400,000.00)

EBIT

$ (175,000.00)

$ (130,000.00)

$ 35,000.00

Taxes

$ 35,000.00

$ 26,000.00

$ (7,000.00)

Net Income

$ (140,000.00)

$ (104,000.00)

$ 28,000.00

Investment

$ (1,200,000.00)

Change in inventory

$ (50,000.00)

$ -

$ 20,000.00

$ 5,000.00

Ending Value of inventory

$ 25,000.00

Change in Accounts Payable

$ 20,000.00

$ -

$ (2,000.00)

$ (3,000.00)

Ending Value of Accounts Payable

$ (15,000.00)

Change in accounts Receivables

$ -

$ (100,000.00)

$ (15,000.00)

$ (55,000.00)

(500000*20%)

(575000 -500000)*20%

(850000 -575000)*20%

Ending Value of Accounts Receivables

$ 170,000.00

Net Cash Flows

$ (1,230,000.00)

$ (240,000.00)

$ (101,000.00)

$ 155,000.00

PVF (15%)

1.00000

0.86957

0.75614

0.65752

PV =Net Cash Flows* PVF

$ (1,230,000.00)

$ (208,695.65)

$ (76,370.51)

$ 101,915.02

Net Present value = Sum of PVs

$ (1,413,151.15)

The NPV is negative, hence project should not be accepted.

Cash flow statement

Revenue

$ 500,000.00

$ 575,000.00

$ 850,000.00

COGS

$ (200,000.00)

$ (230,000.00)

$ (340,000.00)

Gross Margin

$ 300,000.00

$ 345,000.00

$ 510,000.00

SG&A

$ (75,000.00)

Depreciation

$ (400,000.00)

EBIT

$ (175,000.00)

$ (130,000.00)

$ 35,000.00

Taxes

$ 35,000.00

$ 26,000.00

$ (7,000.00)

Net Income

$ (140,000.00)

$ (104,000.00)

$ 28,000.00

Investment

$ (1,200,000.00)

Change in inventory

$ (50,000.00)

$ -

$ 20,000.00

$ 5,000.00

Ending Value of inventory

$ 25,000.00

Change in Accounts Payable

$ 20,000.00

$ -

$ (2,000.00)

$ (3,000.00)

Ending Value of Accounts Payable

$ (15,000.00)

Change in accounts Receivables

$ -

$ (100,000.00)

$ (15,000.00)

$ (55,000.00)

(500000*20%)

(575000 -500000)*20%

(850000 -575000)*20%

Ending Value of Accounts Receivables

$ 170,000.00

Net Cash Flows

$ (1,230,000.00)

$ (240,000.00)

$ (101,000.00)

$ 155,000.00

PVF (15%)

1.00000

0.86957

0.75614

0.65752

PV =Net Cash Flows* PVF

$ (1,230,000.00)

$ (208,695.65)

$ (76,370.51)

$ 101,915.02

Net Present value = Sum of PVs

$ (1,413,151.15)

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