Keener Clothiers Inc. is considering investing $2 million in an automatic sewing
ID: 2683060 • Letter: K
Question
Keener Clothiers Inc. is considering investing $2 million in an automatic sewing machine to produce a newly designed line of dresses. The dresses will be priced at $200, and management expects to sell 12,000 per year for six years. There is, however, some uncertainty about production costs associated with the new machine. The production department has estimated operating costs at 70% of revenues, but senior management realizes that this figure could turn out to be as low as 65% or as high as 75%. The new machine will be depreciated at a rate of $200,000 per year for six years (straight line, zero salvage). KeenerExplanation / Answer
Cost as a % of Revenue
Cash Flow in Years 1-5 @65% @70% @75%
Revenues $2,400 $2,400 $2,400
Operating Costs 1,560 1,680 1,800
Depreciation 200 200 200
EBT Impact 640 520 400
Tax 224 182 140
EAT Impact 416 338 260
Add back depreciation. 200 200 200
Cash Flow 616 538 460
NPVs using a financial calculator yields:
Best Point Est Worst
CFo (2,000) (2,000) (2,000)
C01 616 538 460
F01 6 6 6
I 14 14 14
NPV 395.419 92.103 (211.213)
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