Question

AnimalChin! Co. has decided to sell a new line of longboards: "The Veloce." These longboards will be sold for $462 per unit and have variable costs of $350 per unit. The company has spent $750,000 for a marketing study which determined that the company will sell 4,000,000 boards in year 1. Sales will stay the same until the project is discontinued in year 8. The same marketing study also mentioned that some old clients are likely to switch to the new board. Sales of the other AnimalChin! board The Classic are likely to decrease by 800,000 units each year, the price of The Classic price $400, and variable costs are $300. Space rental, marketing and advertisement costs, and administrative expenses will total $60,000,000 per year. A few months ago, the company has also spent $7,000,000.00 to test new wheels and shock pads and they recently repaired some of their machines for $5,000,000.00. Three of these machines are currently not in use, they could be used for the production of The Veloce or could be sold today for $80,000,000.00 total (their initial cost 3 years ago was $500,000,000.00 (the company is currently depreciating these assets straight-line to zero book value over 5 years). The plant and equipment investment required for this project is $1,700,000,000.00 and will be depreciated on a straight-line basis to a zero book value over the next 8 years. Despite depreciating to zero for tax reasons, the company believes that the market value of the equipment in 8 years will be $90,000,000.00. The company will sell the equipment. The production of The Veloce will require an immediate increase in inventory of $ 145,000,000.00 that will be returned at the end of the project. The tax rate is 40%.

1. Read the project's description very carefully. Which cash-flows are “relevant” for our project? Remember you are looking for incremental cash flows. List which cash-flows are relevant (or not relevant) and briefly explain why. Relevant NOT relevant Why?

2. Based on your answer to question 1. Calculate the annual operating cash-flow (OCF) for the project for year 1 to year 8.

3. Now focus on year 0. Based on your answer to question 1. What should you take into account as inflow/outflow of cash for year 0 when you start the project?

4. Finally, focus on year 8, the termination year of your project. What should you take into account as inflow/outflow of cash besides year 8 OCF?

? 5. Based on points 1-4 fill the CFFA table and compute the Cash-flow from assets (CFFA) for Year 0 to year 8. Copy and paste from excel if needed.

Item	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8
OCF
NCS
ATS
NWC
CFFA

Answer 1

1

Cash Flow:

A

Sales revenue

$        1,848,000,000

Relevant

(4000000*462)

B

Variable cost

$      (1,400,000,000)

Relevant

(4000000*350)

C=A-B

Annual before tax cash flow

$            448,000,000

Relevant

D

Cost of marketing study

($750,000)

Relevant

E

Reduction in cash flow from the Classic sale

($80,000,000)

Relevant

(800000*(400-300)

F

Space rental, marketing advert. Admin etc

($60,000,000)

Not relevant

G

Testing expenses

($7,000,000)

Relevant

H

Repair of machines

($5,000,000)

Not relevant

I

Market Value of old machines (opportunity cost)

($80,000,000)

Relevant

J

Initial cost of machines 3 years ago

($500,000,000)

Not relevant

K

Plant and equipment required for this project

($1,700,000,000)

Relevant

L

Market Value of equipment after 8 years

$90,000,000

Relevant

M

Immediate increase in inventory

($145,000,000)

Relevant

N

Release of inventory after 8 years

$145,000,000

Relevant

P

Tax Rate=40%

2

Annual Operating Cash Flow

C

Annual before tax cash flow

$            448,000,000

Q=C*(1-P)

Annual after tax cash flow

$            268,800,000

E

Annual reduction in cash flow from the Classic sale

($80,000,000)

R=K/8

Annual Depreciation

($212,500,000)

S=-R*P

Annual depreciation tax shield

$              85,000,000

T=Q+E+S

Annual Operating Cash flow

$            273,800,000

3

Initial Cash Flow in Year 0

D

Cost of marketing study

($750,000)

G

Testing expenses

($7,000,000)

I

Market Value of old machines (opportunity cost)

($80,000,000)

K

Plant and equipment required for this project

($1,700,000,000)

M

Immediate increase in inventory

($145,000,000)

Total Initial Cash Flow

($1,932,750,000)

4

Terminal cash Flow in year 8

L

Market Value of equipment after 8 years

$90,000,000

U=L*(1-P)

After tax salvage value

$54,000,000

N

Release of inventory after 8 years

$145,000,000

V=U+N

Total terminal cash flow

$199,000,000

Item

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

Year 8

OCF

$273,800,000

$273,800,000

$273,800,000

$273,800,000

$273,800,000

$273,800,000

$273,800,000

$273,800,000

NCS

($1,932,750,000)

ATS

$54,000,000

NWC

$145,000,000

CFFA

($1,932,750,000)

$273,800,000

$273,800,000

$273,800,000

$273,800,000

$273,800,000

$273,800,000

$273,800,000

$472,800,000