Question

Finco Inc. manufactures financial calculators. The company is deciding whether to introduce a new calculator. This calculator will sell for $100. The company feels that sales will be 12,500, 13,000, 14,000, 13,200, and 12,500 units per year for the next 5 years. Variable costs will be 25% of sales, and fixed costs are $300,000 per year. The firm hired a marketing team to analyze the viability of the product and the marketing analysis cost $1,500,000. The company plans to use a vacant warehouse to manufacture and store the calculators. Based on a recent appraisal the warehouse and the property is worth $2.5 million on an after-tax basis. If the company does not sell the property today then it will sell the property 5 years from today at the currently appraised value. This project will require an injection of net working capital at the onset of the project in the amount of $100,000. This networking capital will be fully recovered at the end of the project. The firm will need to purchase some equipment in the amount of $1,200,000 to produce the new calculators. The machine has a 7-year life and will be depreciated using the straight-line method. At the end of the project, the anticipated market value of the machine is $150,000. The firm requires a 10% return on its investment and has a tax rate of 21%.

1. Calculate the depreciation expense at the end of year 2. (Round to two decimals)
2. Calculate the after-tax salvage value at the end of year 5. (Round to two decimals)
3. Calculate the operating cash flows at the end of year 1. (Round to two decimals)
4. Calculate the initial cash outflow (e.g. the time 0 cash flow). (Enter a negative value and round to two decimals)
5. Calculate the cash flow from assets at the end of year 5. (Round to two decimals)
6. Calculate the net present value for the project. (Round to two decimals)

Answer 1

A) Total Purchase Value of the machine = $1,200,000

Total Life of Machine = 7 years

As the depreciation is charged on straight line method, so the depreciation will calculated as follows

= 1,200,000 / 7 = $ 171,428.57

So the depreciation remains same for all years and the depreciation expense at the end of year 2 will be $171,428.57

B) After tax salvage value of the Machine after 5 years will be

Purchase Price of Asset	$ 12,000,000
Less Depreciation Charged for 5 years (171,428.57*5)	$    857,143
Written down Value of Machine at sale (12,000,000 - 857,143)	$    342,857
Sale value of Machine	$    150,000
Profit/(Loss) on sale of Machine (Written down value - Sale price)	$    -192,857
less tax expenses (-192,857 * 21%)	$    - 40,500
After tax salvage value of Machine (Sale Value - tax expense)	$ 190,500

So after tax salvage value of machine after 5 years is $ 190,500

c) Selling Price of the one Calculator = $ 100

Variable costs associated with one unit = 100 * 25% = $ 25

Contribution per unit = Sale price - variable cost

= 100 - 25 = $ 75

Operating Cash flows of the 1 year are given below

Year	Sales	Contribution per unit	Fixed costs	Depreciation	Profit before tax (sales*contribution) - Fixed costs - Depreciation	Tax deduction	Profit after Tax	Add Depreciation	Operating Cash flow (Profit after tax + Depreciation)
1	12500	$ 75	$ 300,000	$ 171,429	$ 466,071	$ 97,875	$ 368,196	$ 171,429	$ 539,625

Operating Cash flows of the 1st year are $ 539,625

d) Initial cash outflow of the project is as follows

= - (Capital Expenditure incurred + Increase in working capital)

Capital Expenditure = Purchase price of Assets + Procurement of property

= 1,200,000 + 2,500,000 = $ 3,700,000

Initial cash outflow = - ( 3,700,000 + 100,000 ) = $ - 3,800,000

As multiple questions are asked, so the first 4 have been solved.