2. Traid Winds is planning to introduce a new hedge cutter The product will be m
ID: 2721826 • Letter: 2
Question
2. Traid Winds is planning to introduce a new hedge cutter The product will be manufactured in an unused facility that is fully depreciated. The project will be operational for only the next four years of the project: Following are the details The project requires the purchase of new equipment at an invoice cost of $28,500,000. It will cost an additional $1,500,000 to install the equipment. - The capital investment will be depreciated using a 5-year MACRS schedule. schedule is as follows : 20%; 32%; 198; 12%; 11%; and 68. If the project is undertaken, the company will need to increase inventory by $1,200,000. Accounts receivable will increase by $800,000, and accounts payable by $500,000 . To project demand for this new product, the company has spent $3,200,000 in focus groups and pre-market testing. The depreciation The project is expected to generate sales of 200,000 units in the first year: 265, 000 units in each the second and third years, and 300,000 in the fourth year. The sales price per unit will be $75 Variable costs are expected to be 45 percent of revenue. operating depreciation) will equal $800,000 a year . To undertake th project, the firm wil need to borrow $14,000,000 at a rate equal to the marginal cost of debt. Other (excluding costsExplanation / Answer
Calculation of Cash Flows for each year :
Now
Year 1
Year 2
Year 3
Year 4
Sales Units
200,000
265,000
265,000
300,000
Sales Revenue = Sales Units * $75 =
$ 15,000,000.00
$ 19,875,000.00
$ 19,875,000.00
$ 22,500,000.00
Less: Variable costs = Sales Revenue * 45% =
$ (6,750,000.00)
$ (8,943,750.00)
$ (8,943,750.00)
$ (10,125,000.00)
Less: Other Operating costs
$ (800,000.00)
$ (800,000.00)
$ (800,000.00)
$ (800,000.00)
Less: Depreciation (See note below)
$ (6,000,000.00)
$ (9,600,000.00)
$ (5,700,000.00)
$ (3,300,000.00)
Profit Before tax
$ 1,450,000.00
$ 531,250.00
$ 4,431,250.00
$ 8,275,000.00
Less: Tax = Profit before tax * 35% =
$ (507,500.00)
$ (185,937.50)
$ (1,550,937.50)
$ (2,896,250.00)
Profit after tax
$ 942,500.00
$ 345,312.50
$ 2,880,312.50
$ 5,378,750.00
Add: Depreciation
$ 6,000,000.00
$ 9,600,000.00
$ 5,700,000.00
$ 3,300,000.00
Cash Flows after tax
$ 6,942,500.00
$ 9,945,312.50
$ 8,580,312.50
$ 8,678,750.00
Cost of New Equipment
$ (28,500,000.00)
Installation Costs
$ (1,500,000.00)
Investment in inventory
$ (1,200,000.00)
Investment in Accounts receivables
$ (800,000.00)
Increase in Accounts Payable
$ 500,000.00
Net Cash Flows
$ (31,500,000.00)
$ 6,942,500.00
$ 9,945,312.50
$ 8,580,312.50
$ 8,678,750.00
Note : Calculation of Depreciation :
Cost = (28500000+1500000) = 30000000
Depreciation rate
20%
32%
19%
11%
Depreciation = Cost *Depreciation rate
$ 6,000,000.00
$ 9,600,000.00
$ 5,700,000.00
$ 3,300,000.00
Note : Cost incurred on pre market testing is irrelevant, hence ignored.
(Furthre parts can not be done becuase WACC is missing )
Calculation of Cash Flows for each year :
Now
Year 1
Year 2
Year 3
Year 4
Sales Units
200,000
265,000
265,000
300,000
Sales Revenue = Sales Units * $75 =
$ 15,000,000.00
$ 19,875,000.00
$ 19,875,000.00
$ 22,500,000.00
Less: Variable costs = Sales Revenue * 45% =
$ (6,750,000.00)
$ (8,943,750.00)
$ (8,943,750.00)
$ (10,125,000.00)
Less: Other Operating costs
$ (800,000.00)
$ (800,000.00)
$ (800,000.00)
$ (800,000.00)
Less: Depreciation (See note below)
$ (6,000,000.00)
$ (9,600,000.00)
$ (5,700,000.00)
$ (3,300,000.00)
Profit Before tax
$ 1,450,000.00
$ 531,250.00
$ 4,431,250.00
$ 8,275,000.00
Less: Tax = Profit before tax * 35% =
$ (507,500.00)
$ (185,937.50)
$ (1,550,937.50)
$ (2,896,250.00)
Profit after tax
$ 942,500.00
$ 345,312.50
$ 2,880,312.50
$ 5,378,750.00
Add: Depreciation
$ 6,000,000.00
$ 9,600,000.00
$ 5,700,000.00
$ 3,300,000.00
Cash Flows after tax
$ 6,942,500.00
$ 9,945,312.50
$ 8,580,312.50
$ 8,678,750.00
Cost of New Equipment
$ (28,500,000.00)
Installation Costs
$ (1,500,000.00)
Investment in inventory
$ (1,200,000.00)
Investment in Accounts receivables
$ (800,000.00)
Increase in Accounts Payable
$ 500,000.00
Net Cash Flows
$ (31,500,000.00)
$ 6,942,500.00
$ 9,945,312.50
$ 8,580,312.50
$ 8,678,750.00
Note : Calculation of Depreciation :
Cost = (28500000+1500000) = 30000000
Depreciation rate
20%
32%
19%
11%
Depreciation = Cost *Depreciation rate
$ 6,000,000.00
$ 9,600,000.00
$ 5,700,000.00
$ 3,300,000.00
Note : Cost incurred on pre market testing is irrelevant, hence ignored.
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