Kramerica Industires plans to introduce a new product to the market. Last week,
ID: 2797097 • Letter: K
Question
Kramerica Industires plans to introduce a new product to the market. Last week, Kramerica hired a marketing firm to develop a TV ad for the product. The marketing firm will develop the ad regardless of Kramerica's decision to continue the project or not. The project will require additional working capital of $300,000 which will be recovered at the conclusion of the project. The firm has spent $250,000 on R&D for this project. To launch the project Kramerica will have to invest $26 million today in plant and machinery. The plant and machinery have an economic life of 20 years and a salvage value of $4 million. The project is expected to generate sales of $9 million per year for 20 years. Of these, 20% are due to lost sales of the existing products of the company. The incremental variable costs of producing the product is $3.4m. Fixed costs are $700,000 per year. Kramerica's accountants have allocated $400,000 in managerial salaries to the project but no additional managers need to be hired. The company uses straight line depreciation. It has a marginal tax rate of 40% and a 10% cost of capital. The cash flow in year 5 (t=5) is $________.
Kramerica Industires plans to introduce a new product to the market. Last week, Kramerica hired a marketing firm to develop a TV ad for the product. The marketing firm will develop the ad regardless of Kramerica's decision to continue the project or not. The project will require additional working capital of $300,000 which will be recovered at the conclusion of the project. The firm has spent $250,000 on R&D for this project. To launch the project Kramerica will have to invest $26 million today in plant and machinery. The plant and machinery have an economic life of 20 years and a salvage value of $4 million. The project is expected to generate sales of $9 million per year for 20 years. Of these, 20% are due to lost sales of the existing products of the company. The incremental variable costs of producing the product is $3.4m. Fixed costs are $700,000 per year. Kramerica's accountants have allocated $400,000 in managerial salaries to the project but no additional managers need to be hired. The company uses straight line depreciation. It has a marginal tax rate of 40% and a 10% cost of capital.
The initial cash flow at time 0 (t=0) is -$______.
Explanation / Answer
Cash flow in year = 5 or t=5,
Sales each year = $ 9,000,000
Lost salesofother products due to new product = 20% of 9,000,000 = $1,800,000
so, net sales = $7,200,000
Costs can be divided into :
1. Variable cost = $3,400,000
2. Fixed cot = $700,000
3. Manegerial cost = $400,000
So cash flow in year 5 = Net sales - Variable cost - manegerial cost - fixed cost = $7,200,000 - 3,400,000 - 700,000 - 400,000 = $2,700,000
Initial cash flow at time = or t=0 can be detrmined a initial working capital cost and amount requird to be invested into plant and machinery. R&D cost will not considered as it has already been spent.
So, initial cash flow at t=0 = $26,000,000 + $300,000 = $26,300,000
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