Question

You have been hired as new analyst at Foxconn Interconnect Technology Limited (FIT) and have been asked to evaluate the new manufacturing plant to produce new state of art internet security system.

Suppose that FIT is considering expanding its wireless home networking appliance, called EasyNet, that will provide both the hardware and the software necessary to run an entire home from any Internet connection. EasyNet will also control new Internet-capable stereos, digital video recorders, heating and air-conditioning units, major appliances, telephone and security systems, office equipment, and so on. Based on extensive marketing surveys, the sales forecast for EasyNet is 50,000 units per year. Given the pace of technological change, FIT expects the product will have a five-year life and an expected wholesale price of $180 (the price FIT will receive from stores). Actual production will be outsourced at a cost (including packaging) of $80 per unit.

To verify the compatibility of new consumer Internet-ready appliances with the EasyNet system as they become available, FIT must also establish a new lab for testing purposes. They will rent the lab space but will need to purchase $5 million of new equipment. The equipment will be depreciated using the straight-line method over a 5-year life. FIT' marginal tax rate is 21%.

The lab will be operational at the end of one year. At that time, EasyNet will be ready to ship. FIT expects to spend $1 million per year on rental costs for the lab space, as well as rent marketing and support for this product. Suppose that FIT will have no incremental cash or inventory requirements (products will be shipped directly from the contract manufacturer to customers).

However, receivables related to FIT are expected to account for 15% of annual sales, and payables are expected to be 15% of the annual cost of goods sold (COGS).

Question:

1. Forecast the incremental cash flow from the EasyNet project.

Answer 1

Formula	Time (n)	0	1	2	3	4	5
	Equipment cost (EC)	5000000
	Sales unit (Q)		50000	50000	50000	50000	50000
	Price per unit (p)		180	180	180	180	180
Direct cost	Production cost per unit (pc)		80	80	80	80	80
Q*p	Sales revenue (S)		9000000	9000000	9000000	9000000	9000000
Q*pc	COGS		4000000	4000000	4000000	4000000	4000000
Rental cost	Fixed cost (FC)		1000000	1000000	1000000	1000000	1000000
EC/5	Depreciation (D)		1000000	1000000	1000000	1000000	1000000
S-COGS-FC-D	EBIT		3000000	3000000	3000000	3000000	3000000
21%*EBIT	Tax @ 21%		630000	630000	630000	630000	630000
EBIT-Tax	Net income (NI)		2370000	2370000	2370000	2370000	2370000
	Add: Depreciation (D)		1000000	1000000	1000000	1000000	1000000
NI+D	Operating cash flow (OCF)		3370000	3370000	3370000	3370000	3370000
15%*S	Receivables ('R)		1350000	1350000	1350000	1350000	1350000
15%*COGS	Payables (P)		600000	600000	600000	600000	600000
R-P	NWC		750000	750000	750000	750000	0
NWCn-1 - NWCn	Increase in NWC		-750000	0	0	0	750000
OCF -EC - Inc. in NWC	Incremental cash flow (ICF)	-5000000	2620000	3370000	3370000	3370000	4120000