Question

After spending a year and ​$50,000​, you finally have the design of your new product ready. In order to start​ production, you will need ​$30,000 in raw materials and you will also need to use some existing equipment that​ you've fully​ depreciated, but which has a market value of ​$100,000. Your colleague notes that the new product could represent 10​% of the​ company's overall sales and that 10​% of overhead is ​$60,000. Your tax rate is 40​%. As you start your analysis of the​ product, what should be your initial incremental free cash​ flow?

Answer 1

Market value of old equipment used= -100000  
Tax saved on capital gain (100000*40%)= 40000  
investment in raw material =. -30000  
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Initial incremetal free cash flow -90000  
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(1) Machine book value is 0 which is used for production, while market value is $100000      
if not used, it could be sold for $100000. Due to use in project, $100000 is lost. So it is opportunity cost.      
      
(2)Tax is saved on capital gain. so it is benefit to be considered in initial incremetal Cash out flow      
      
(3) $ 50000 spend for designing is sunk cost. it is irrelevant for decision. As this cost has already been incurred       
      
(4) overhead allocated is also irrelevant for decision. As this is not incurred DUE to project.      

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