Question

After reading a demographic study on the habits and modern lifestyles of the American public, TI Inc. decided launching a new product, Gizmo ™. TI’s CEO has asked you to determine whether or not to go ahead with the introduction of a new product. You have the following information:

• Most of the numbers for your estimates come from a study by marketing consultant that you received two months ago. The consulting fee was $80,000.

• You will locate the production line for the product in a currently unused building with a current after-tax market value of $600,000. The warehouse has already been depreciated so its book value is zero.

• The new equipment you must buy will cost $900,000. The equipment will be depreciated on a straight line basis over 10 years to zero.

• You have just received the results of a marketing survey that indicates that revenues from sale of Gizmo ™ will be $650,000 per year for 10 years.

• Variable costs will be 40% of sales per year.

• Fixed costs will be $170,000 per year.

• It is expected that at the end of year 10 you can sell the warehouse and equipment for $120,000.

• TI’s marginal tax rate is 30%.

a) What is the appropriate amount to use as the initial cash flow (CFo)?

b) What is the appropriate amount to use as the annual operating cash flows from the project (OCF)?

c) Determine the after-tax salvage value of the project (the cash flow at the end of the project that comes from the sale of the project’s assets

Answer 1

Initial Investment
New Equipment		900000
Consulting Fee		80000
Building		600000
		1580000

Year	0	1	2	3	4	5	6	7	8	9	10	10
Initial Investment	1580000
Revenue Per year		650000	650000	650000	650000	650000	650000	650000	650000	650000	650000
Less:- Variable Cost		260000	260000	260000	260000	260000	260000	260000	260000	260000	260000
Less:- Fixed Cost		170000	170000	170000	170000	170000	170000	170000	170000	170000	170000
EBIT		220000	220000	220000	220000	220000	220000	220000	220000	220000	220000
( Taxes ) @40%		-160000	-160000	-160000	-160000	-160000	-160000	-160000	-160000	-160000	-160000
New Dep		90000	90000	90000	90000	90000	90000	90000	90000	90000	90000
Salvage Value												120000
( Tax on Salvage )												-36000
TOTAL FREE CF	-1580000	150000	150000	150000	150000	150000	150000	150000	150000	150000	150000	84000
Answer-1
the appropriate amount to use as the initial cash flow (CFo)			=	1580000
Answer -2
the appropriate amount to use as the annual operating cash flows from the project					=	150000
Answer-3
the after-tax salvage value of the project (the cash flow at the end of the project that comes from the sale of the project’s assets
						=	84000