Question

Gemini Car Parts (GCP) Inc., a multinational corporation, is a major supplier of a broad range of components to the worldwide automobile and light truck market. GCP is in the process of developing a bid to supply an ignition system module to Samoa Igni Company (SIC), a South Korean automobile manufacturer, for a new line of automobiles for the next four-year production cycle. The Request for Proposal issued by SIC specifies a quantity of 200,000 modules in the first year and 250,000 units in years 2 through 4 of the contract. GCP marketing specialists believe that, in order to be competitive, a bid of 100,000 South Korean Won (KRW) per unit is appropriate. Other relevant data are shown below.

• Manufacturing specialists estimate that a $12 million (U.S. Dollars) investment in equipment (including installation) is required.

• The equipment is expected to last the 4-year life of the contract, at which time it would cost $1.4 million to remove the equipment which would be sold for a scrap value of $900,000.

• Direct labor and material expenses are estimated at $40 per unit.

• The change in indirect cash expenses associated with this contract is expected to be $3 million per year.

• The new product will require additional investment in inventory and accounts receivable balances at the outset, amounting to $1.2 million during the four-year time period. This investment will be recovered at the end of the four-year contract. • GCP is subject to U.S. income tax at an effective rate of 40%.

• For tax purposes, assume that the initial $12 million cost of the equipment is depreciated evenly over the four-year period.

• The company economist estimates that the exchange rate will average 1,250 KRW per U.S. Dollar for the four-year time period.

REQUIRED:

A. Calculate the after-tax incremental cash flows in U.S. Dollars for the following periods:

1. Period 0.

2. Period 1.

3. Period 4 operating cash flow

4. Period 4 terminal cash flow.

B. The assumptions used to develop the cash flows are subject to various degrees of estimation error. For each of three different cash flow variables, identify and discuss one potential risk that could affect the estimates made by GCP.

This is all information I have that provided by the professor.

Answer 1

		Cash flow in Period 0
		Investment in Equipment	$12,000,000
		Inventory and accounts receivable	$1,200,000
		Total cash flow in period 0	$13,200,000
		Cash flow in Period 1
	A	Sales Quantity in period 1	200000
	B	Bid per unit in KRW	100000
	C	Bid per unit in USDollar	$                   80.00	(100000/1250)
	D=A*C	Sales Revenue	$        16,000,000	(80*200000)
	E=40*A	Direct materialand labor expenses	$          8,000,000
	F	Indirect cash expense	$3,000,000
	G	Depreciation expense	$3,000,000	(12000000/4)
	H=D-E-F-G	Before tax earning	$          2,000,000
	I=H*0.4	Tax expense	$              800,000
	J=H-I	After tax earning	$          1,200,000
	K=J+G	After tax Cash Flow	$          4,200,000
		Cash flow in Period 1	$          4,200,000
		Operating Cash flow in Period 4
	A	Sales Quantity in period 4	250000
	B	Bid per unit in KRW	100000
	C	Bid per unit in USDollar	$                   80.00
	D=A*C	Sales Revenue	$        20,000,000
	E=40*A	Direct materialand labor expenses	$        10,000,000
	F	Indirect cash expense	$3,000,000
	G	Depreciation expense	$3,000,000
	H=D-E-F-G	Before tax earning	$          4,000,000
	I=H*0.4	Tax expense	$          1,600,000
	J=H-I	After tax earning	$          2,400,000
	K=J+G	After tax Cash Flow	$          5,400,000
		Operating Cash flow in Period 4	$          5,400,000
		Terminal Cash flow in Period 4
	L	Scrap value	$900,000
	M	Cost of removing equipment	$1,400,000
	N=L-M	Net cash flow for equipment removal	($500,000)
	P	Release of inventory and accounts receivable balance	$1,200,000
	Q=N+P	TerminalCash Flow period 4	$700,000