Question: :> Ocean Company is a toy company, it produces a variety of toys for n
ID: 2691922 • Letter: Q
Question
Question: :>
Ocean Company is a toy company, it produces a variety of toys for newborn babies & children up to 10 years old. Last year, the company hired a consultant at a cost of $2,200,000 to estimate the development of painting kits. The consultant pointed out that a new launch of painting kits would be able to stimulate sales of the company. Additional sales revenue of $22,400,000 per year will be generated by this new product. The expenditure incurred in this new product is listed below:
If the company accepts this new product, the annual cash expenses of the company will increase from $84,000,000 to $86,800,000.
The company has to borrow $40,000,000 from a bank. The bank offers the company 8% interest and additional interest expenses of $3,200,000 each year.
Additional inventory of $8,400,000 will be incurred for the new product.
The new machine will cost $50,400,000, with a useful life of four years. The company applies the simplified straight-line method over the useful life period. This new machine should be installed before the new project formally starts.
Assume the marginal tax rate is 18% and the required rate of return for the company is 10%. As the finance manager of the company, you are required to review this project.
Review and decide whether the following items are relevant cash flows for the project or not.
<<Require>>
(a)
i) The consulting fee: $2,200,000
ii) The increase in inventory: $8,400,000
iii)Additional interest expense: $3,200,000 per year.
(b)Develop a capital budgeting analysis to determine whether the company should accept this project.
***Would you kindly please to show the calculation steps clearly in order to get full credit.***
Million Thanks!!!
Explanation / Answer
The new machine will cost $50400000 with a useful life of four years. The company applies the simplified straight-line method over the useful life period. This new machine should be installed before the new project formally starts. Assume the marginal tax rate is 18% and the required rate of return for the company is 10%. As the finance manager of the company, you are required to review this project. Review and decide whether the following items are relevant cash flows for the project or not. A.) i The consulting fee:$2200000 ii The increase in inventory: $8400000 iii Additional interest expense:$3200000 per year. B.) Develop a capital budgeting analysis to determine whether the company should accept this project. Remember to show the calculation steps clearly in order to get full credit. Please help, Thx can you tell me how different between depreciation and depreciation expense?one is need to /4yrs? the other one is total amount? A) i) No. The consulting fee is a sunk cost ii) Yes. The increase in net working capital is assumed recaptured at the end of the project life. iii) No. The discount rate will "account" for the financing. B) Calculate the intial cash outflow "CF0" = cost of machine + additional inventory (aka the increase in Net Working Capital "NWC") The CF0 is represented as a negative number when calculating NPV to reflect it as a cash OUTflow. Warning: Tricky language here: "This new machine should be installed before the new project formally starts." Usually that implies a sunk cost that would not be accounted for here but that’s a weird phrase, so assume you do account for it. Calculate annual incremental cash flows (CF’s 1-4): [(Additional Sales - just the change in expenses - depreciation)(1 - 0.18)] + depreciation expense In the 4th year ("CF4"), to the annual cash flows, add back the additional inventory expense (eg. recapture the increase in NWC) Calc NPV = (CF0) + CF1/1.10 + CF2/1.10^2 + CF3/1.10^3 + CF4/1.10^4 If the number is positive you accept the project, if not, you don’t. Hope this helps. Now all you have to do is a little math!
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