Question

Given the soaring price of gasoline, Ford is considering introducing a new production line of gas-electric hybrid sedans. The expected annual unit sales of the hybrid cars is 22,000; the price is $26,000 per car. Variable costs of production are $14,000 per car. The fixed overhead including salary of top executives is $80 million per year.

However, the introduction of the hybrid sedan will decrease Ford’s sales of regular sedans by 9,000 cars per year; the regular sedans have a unit price of $20,000, a unit variable cost of $12,000, and fixed costs of $250,000 per year. Depreciation costs of the production plant are $46,000 per year. The marginal tax rate is 40 percent.

What is the incremental annual cash flow from operations?

Answer 1

The expected annual unit sales of the hybrid cars is 22,000; the price is $26,000 per car. Variable costs of production are $14,000 per car.

Incremental contribution = (Sale price - variable cost) x Sale volume = (26,000 - 14,000) x 22,000 =  264,000,000

However, the introduction of the hybrid sedan will decrease Ford’s sales of regular sedans by 9,000 cars per year; the regular sedans have a unit price of $20,000, a unit variable cost of $12,000

Lost contribution = (Sale price - variable cost) x Sale volume = (20,000 - 12,000) x 9,000 = 72,000,000

The fixed costs are not incremental. They will be there irrespective of the decision.

Incremental EBIT = Incremental contribution - lost contribution - Depreciation = 264,000,000 - 72,000,000 - 46,000 =  191,954,000

The marginal tax rate is 40 percent.

hence, the incremental annual cash flow from operations = Incremental EBIT x (1 - T) + Depreciation = 191,954,000 x (1 - 40%) + 46,000 = $  115,218,400