Sugar Land Company is considering adding a new line to its product mix, and the

Question

Sugar Land Company is considering adding a new line to its product mix, and the capital budgeting analysis is being conducted by a MBA student. The production line would be set up in unused space (Market value of zero) in Sugar Land’ main plant. Total cost of the machine is $190,000. The machinery has an economic life of 4 years, and MACRS will be used for depreciation. The machine will have a salvage value of 30,000 after 4 years.

The new line will generate Sales of 1,300 units per year for 4 years and the variable cost per unit is $100 in the first year. Each unit can be sold for $200 in the first year. The sales price and variable cost are expected to increase by 3% per year due to inflation. Further, to handle the new line, the firm’s net working capital would have to increase by $30,000 at time zero (The NWC will be recouped in year 4). The firm’s tax rate is 40% and its weighted average cost of capital is 10%.

Calculate the annual sales revenues and costs (other than depreciation), years 1 through 4.

Explanation / Answer

Calculation of annual sales revenue and Costs (other than depreciation), years 1 through 4. Year 1 Year 2 Year 3 Year 4 A Sales (Units) 1300 1300 1300 1300 B Selling price per unit            200.00            206.00            212.18            218.55 C   Sales   (A*B)    260,000.00    267,800.00    275,834.00    284,109.02 D Variable Cost per unit            100.00            103.00            106.09            109.27 E Variable Cost (A*D)    130,000.00    133,900.00    137,917.00    142,054.51

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