Question

1. The Appalacian Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30,000 and the machine will be depreciated straight-line over its three-year life to a residual value of $0.

The cane manufacturing machine will result in sales of 2000 canes in year 1. Sales are estimated to grow by 10% per year each year through year three. The price per cane that Sisyphean will charge its customers is $18 each and is to remain constant. The canes have a manufacturing cost of $9 each.

Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Appalacian Corporation needs to hold 2% of its annual sales in cash, 4% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 6% of its annual sales in accounts payable. The firm is in the 21% tax bracket, and has a cost of capital of 10%.

1.) Calculate EBIT and net income for the 3 years.

2.) Calculate the net working capital required for each of the three years.

3.) Calculate the free cash flow for each year relevant for the project.

Answer 1

Solution:

The details provided in the question are,

Machine Cost - $30,000

Machine Life - 3 years

Residual value - $0

Sales in Year 1 - 2000 canes

Sales in Year 2 (Estimated grow 10%) - 2200 canes

Sales in Year 3 (Estimated grow 10%) - 2420 canes

Selling Price - $18

Cost of Good - $ 9

Tax Rate - 21%

1)Calculation of the EBIT and Net Income for 3 years,

Year	1	2	3
Sales (A)	36000	39600	43560
Depreciation	0	0	-10000
Cost of goods sold	18000	19800	21780
Total Cost (B)	18000	19800	11780
Profit before Tax (EBT)                 (C =A-B)	18000	19800	31780
Tax 21% (D =C*21%)	3780	4158	6673.8
Profit After Tax (EAT)                  (E=C-D)	14220	15642	25106.2

EBIT for 3 years = $69,580 (Sum of 3 years EBT from Table)

Net Income for 3 years = $54,968.20 (Sum of 3 years EAT from Table)

2) Calculation of the net working capital required for each of the three years,

Net Working Capital = Current Asset - Current Liablities

Year	1	2	3
Annual Sale	36000	39600	43560
Cash (2% of Annual Sale) (A)	720	792	871.2
Recivable (4% Annual Sale) (B)	1440	1584	1742.4
Inventory (9% of Annual Sale) (C)	3240	3564	3920.4
Current Asset (A+B+C)	5400	5940	6534
Current Liabilities (Payable, 6% of Annual Sale	2160	2376	2613.6
Net Working Capital (Current Asset - Current Liability)	3240	3564	3920.4

3) Calculation of the free cash flow for each year relevant for the project,

Year	1	2	3
Sales (A)	36000	39600	43560
Depreciation	0	0	-10000
Cost of goods sold	18000	19800	21780
Total Cost (B)	18000	19800	11780
Profit before Tax (EBT)                 (C =A-B)	18000	19800	31780
Tax 21% (D =C*21%)	3780	4158	6673.8
Profit After Tax (EAT)                  (E=C-D)	14220	15642	25106.2
Free Cash Flow (EAT + Depreciation)	14220	15642	15106.2