Sugar Land Company is considering adding a new line to its product mix, and the
ID: 2801255 • Letter: S
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%.
A. Estimate annual (Year 1 through 4) operating cash flows
B. Estimate the after tax salvage cash flow
C. Estimate the cash flow of this project
Year 1 Year 2 Year 3 Year 4 Sales OCFExplanation / Answer
MACRS Depreciation Year Depn Rate Depn Book Value 0 1,90,000 1 33.33% 63,327 1,26,673 2 44.45% 84,455 42,218 3 14.81% 28,139 14,079 4 7.41% 14,079 - Year 1 Year 2 Year 3 Year 4 Sales (units) 1,300.00 1,300.00 1,300.00 1,300.00 Sales (Rate) 200.00 206.00 212.18 218.55 Sales (Value) 2,60,000.00 2,67,800.00 2,75,834.00 2,84,109.02 Variable cost (p.U) 100.00 103.00 106.09 109.27 Total Variable cost 1,30,000.00 1,33,900.00 1,37,917.00 1,42,054.51 Contibution 1,30,000.00 1,33,900.00 1,37,917.00 1,42,054.51 Depreciation 63,327.00 84,455.00 28,139.00 14,079.00 EBT 66,673.00 49,445.00 1,09,778.00 1,27,975.51 Tax at 40% 26,669.20 19,778.00 43,911.20 51,190.20 PAT 40,003.80 29,667.00 65,866.80 76,785.31 Depn 63,327.00 84,455.00 28,139.00 14,079.00 OCF 1,03,330.80 1,14,122.00 94,005.80 90,864.31 Year Zero Year 1 Year 2 Year 3 Year 4 NPV CF of the project -2,20,000 1,03,330.80 1,14,122.00 94,005.80 1,38,864.31 Disc Factor 1.00000 0.90909 0.82645 0.75131 0.68301 Disc Cash flow -2,20,000 93,937 94,316 70,628 94,846 1,33,727 Initial outflow (year 0) Machine Cost 1,90,000 NWC 30,000 Total 2,20,000 Residual value post tax at the end of the 4th year NWC 30,000 Salvage value of M/c 30,000 Tax on Salvage value -12,000 Residual value 48,000
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