Kramerica Industires plans to introduce a new product to the market. Last week,

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 condusion of the project. The fim 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 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 $ . allocated $400,000 in managerial salaries to the project but no additional managers need to be hired. The 2,300,000 O 2,320,000 2,350,000 2,380,000 2,.400,000

Explanation / Answer

statement of cash flow

sales

7200000

less variable cost

3400000

contribution

3800000

less fixed cost

700000

operating profit before depreciation

3100000

less depreciation

1300000

operating profit

1800000

less tax 40%

720000

after tax cash flow

1080000

add depreciation

1300000

net cash flow at year 5

2380000

statement of cash flow

sales

7200000

less variable cost

3400000

contribution

3800000

less fixed cost

700000

operating profit before depreciation

3100000

less depreciation

1300000

operating profit

1800000

less tax 40%

720000

after tax cash flow

1080000

add depreciation

1300000

net cash flow at year 5

2380000

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