Question

AnimalChin! Co. has decided to sell a new line of longboards: "The Veloce." These longboards will be sold for $233 per unit and have variable costs of $100 per unit. The company has spent $143,000 for a marketing study which determined that the company will sell 1,800,000 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 100,000 units each year, the price of The Classic price $256, and variable costs are $111. Space rental, market-ing and advertisement costs, and administrative expenses will total $19,000,000 per year. A few months ago, the company has also spent $3,000,000.00 to test new wheels and shock pads and they recently repaired some of their machines for $2,000,000.00. 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 $24,000,000.00 total (their initial cost 3 years ago was $90,000,000.00 (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 $900,000,000.00 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 $40,000,000.00. The company will sell the equipment. The production of The Veloce will require an immedi-ate increase in inventory of $ 125,000,000.00 that will be returned at the end of the project. The tax rate is 40%.

1) Calculate the annual operating cash-flow (OCF) for the project for year 1 to year 8. (Show work.)

2) 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? (Show work.)

3) 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? (Show work.)

Answer 1

1) Calculation of yearly operating cash flows
Year	1	2	3	4	5	6	7	8
Increase in net contribution (WN-1)	224,900,000	224,900,000	224,900,000	224,900,000	224,900,000	224,900,000	224,900,000	224,900,000
Less: Rent, marketing and other costs	-19,000,000	-19,000,000	-19,000,000	-19,000,000	-19,000,000	-19,000,000	-19,000,000	-19,000,000
Less: Depreciation
- Old machines (90000000/5)	-18,000,000	-18,000,000	0	0	0	0	0	0
- New machines (900000000/8)	-112,500,000	-112,500,000	-112,500,000	-112,500,000	-112,500,000	-112,500,000	-112,500,000	-112,500,000
PBT	75,400,000	75,400,000	93,400,000	93,400,000	93,400,000	93,400,000	93,400,000	93,400,000
Less: Tax @40%	-30,160,000	-30,160,000	-37,360,000	-37,360,000	-37,360,000	-37,360,000	-37,360,000	-37,360,000
PAT	45,240,000	45,240,000	56,040,000	56,040,000	56,040,000	56,040,000	56,040,000	56,040,000
Add: Depreciation	130,500,000	130,500,000	112,500,000	112,500,000	112,500,000	112,500,000	112,500,000	112,500,000
Operating cash flows	175,740,000	175,740,000	168,540,000	168,540,000	168,540,000	168,540,000	168,540,000	168,540,000

2) Year 0 cash flows
Cost of new equipment	-900,000,000
Less: salvage, net of tax of old machines (WN-2)	28,800,000
Add: W.Capital required	-125,000,000
Total cash outflow in year 0	-996,200,000

3) Year 8 cash flow besides OCF
salvage, net of tax of new machine (WN-3)	24,000,000
Add: Return of W.Capital investment	125,000,000
Total cash inflow in year 8	149,000,000

WN-1:

Per annum increase in contribution from year 1 to 8
New Product: Veloce
SP per unit	233
V.Cost per unit	100
Contribution per unit	133
Sales (units)	1,800,000
Increase in Contribution ($)	239,400,000
Loss in sales of old product
SP per unit	256
V.Cost per unit	111
Contribution per unit	145
Sales (units)	100,000
Decrease in Contribution ($)	14,500,000
Increase in net contribution =239,400,000-14,500,000)	224,900,000

WN-2:

WN-2: salvage, net of tax of old machines
Purchase price	90,000,000
Depreciation till date (90000000*3/5)	-54,000,000
WDV	36,000,000
Sale Price	24,000,000
Loss on sale	12,000,000
Tax saving on loss	4,800,000
salvage, net of tax (24000000+4800000)	28,800,000

WN-3:

WN-3: salvage, net of tax of new machine
WDV	0
Sale Price	40,000,000
Profit on sale	40,000,000
Tax on profit	-16,000,000
salvage, net of tax (40000000-16000000)	24,000,000

WN-4:

Sunk costs
marketing study	143,000
test expenses	3,000,000
Repair of machines	2,000,000
Total	5,143,000

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