Kaffie Frederick is considering an expansion of it\'s operations by introducing

ID: 2718453 • Letter: K

Question

Kaffie Frederick is considering an expansion of it's operations by introducing a new product line. In order to expand, they will have to buy new machinery for $1,000,000. The machinery will be depreciated using three-year MACRS (33%, 45%, 15%, 7%). In four years they will be able to sell the machinery for $250,000. If they go through with the planned expansion, Sales of the new product will be $750,000 per year and sales of the old product will rise by $50,000 per year. Variable Costs on the new product are 75% of new product sales while variable costs on the old product are 65% of old product sales. The new project will require additional fixed costs of $20,000 per year. The tax rate is 40%. What are the incremental cash flows associated with this proposed project?

Balance Sheet Effects |----------Depreciation Expenses-------------|

Today Year 1 Year 2 Year 3 Year 4 Year 5 End

1. Buy New Assets

2. Trade In Old Assets

3. Keep Old Assets

4. Change in NWC

Income Statement Effects

Year 1 Year 2 Year 3 Year 4 Year 5

Net Sales

- Net COGS

- Net Depreciation

- Net Fixed Costs

= Net OEBT

- Net Taxes

= Net OEAT

+ Net Depreciation

= Net Operating CF

Total Cash Flows

CF0 =

C01 =

C02 =

C03 =

C04 =

C05 =

C06 =

5. What is the Initial Cost of this project?

a)$500,000

$1,000,000

c)$1,500,000

d)$2,000,000

6. What is net depreciation expense on the income statement in Year 1?

a)$175,000

b)$250,000

c)$330,000

d)$475,000

7. What is the After Tax Salvage Value of selling the equipment at the end?

a)$110,000

b)$150,000

c)$175,000

d)$215,000

8. What is the Operating Cash Flow in Year 2

a)$238,000

b)$291,000

c)$363,000

d)$422,000

Explanation / Answer

5)Initial Cost of the Project = Cost of new machinery

= $1,000,000 (Option-b)

6) net depreciation expense on the income statement in Year 1 = $330,000 (Option-C)

7) the After Tax Salvage Value of selling the equipment at the end

Book Value at the end = Nil

Sale Value = $250,000

Profit On Sale = 250,000

Tax on Profit = 250,000*40%

= 100,000

Net Sales Proceeds = 250,000 – 100,000

=$150,000 (Option-b)

8)From Table = $291,000 (Option-b)