Question

The production line produces a product which currently has annual sales of $1,000,000 and has a contribution to the business beyond ingredients of $500,000. Your line is currently operating at full standard capacity. You are putting in new equipment which will make the line more efficient and last for 10 years. The equipment will increase the capacity of the line by 30%. - so, add capability to produce $300,000 more per year   and will eliminate 3 positions of manual labor when fully operational the second year. A manual position of labor costs $30000 per year with benefits. A 6-month supply of ingredients is always kept. It is expected that the learning curve will result in zero increased capacity in year 1 but the full 30% in year 2   . The equipment will costs $600000 engineering and installation will cost $100000. Sales will grow at a rate so all production can be sold. Advertising and promotion to get that growth will cost $50,000 per year. The company has a WACC of 15% but uses a hurdle rate of 18% for projects of this risk type.                   OUTLINE THE CASH FLOWS IN THE CHART BELOW - please note some cash flows are positive and some are negative - you will need to make sure they sum appropriately                                                                 EVALUATE THE INVESTMENT WITH PAYBACK, IRR and NPV

CASH FLOW CALCULATIONS:                                               

Capacity of new line, sales growth, additional ingredients, additional advertising, savings from eliminating manual positions, increase in income before taxes, Depreciation, Estimated taxes at 35%, increase in income after taxes + depreciation, additional inventory, cost of equipment, cost of installation, and Net Cash Flow.

Answer 1

Cashflow	1	2	3	4	5	6	7	8	9	10	Comment
Sales	1,000,000	1,300,000	1,300,000	1,300,000	1,300,000	1,300,000	1,300,000	1,300,000	1,300,000	1,300,000
Less - Ingredient Cost*	500,000	650,000	650,000	650,000	650,000	650,000	650,000	650,000	650,000	650,000
Less -Labour Cost	90,000	-	-	-	-	-	-	-	-	-	30000*3
Less - Advertising	50,000	50,000	50,000	50,000	50,000	50,000	50,000	50,000	50,000	50,000
Less - Taxes	101,500	185,500	185,500	185,500	185,500	185,500	185,500	185,500	185,500	185,500
Less - Instrument Cost	700,000	-	-	-	-	-	-	-	-	-
Less - WC (extra inventory)	250,000	325,000	325,000	325,000	325,000	325,000	325,000	325,000	325,000	325,000
Net Cashflow	(691,500)	89,500	89,500	89,500	89,500	89,500	89,500	89,500	89,500	89,500
*Assumed to be same rate as yr 1

PnL (Taxes computation)	1	2	3	4	5	6	7	8	9	10	Comment
Sales	1,000,000	1,300,000	1,300,000	1,300,000	1,300,000	1,300,000	1,300,000	1,300,000	1,300,000	1,300,000
Less - Ingredient Cost	500,000	650,000	650,000	650,000	650,000	650,000	650,000	650,000	650,000	650,000
Gross Margin	500,000	650,000	650,000	650,000	650,000	650,000	650,000	650,000	650,000	650,000
Less -Labour Cost	90,000	-	-	-	-	-	-	-	-	-	30000*3
Less - Advertising	50,000	50,000	50,000	50,000	50,000	50,000	50,000	50,000	50,000	50,000
Net Margin	360,000	600,000	600,000	600,000	600,000	600,000	600,000	600,000	600,000	600,000
less - Instrument Dep*	70,000	70,000	70,000	70,000	70,000	70,000	70,000	70,000	70,000	70,000
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