Superior Manufacturing is lauching a new product, that is expected to sell $950,000 of its new product the first year alone, and $1,500,000 each year thereafter. Direct cost labor and materials will be 55% in sales.indirect cost is $80,000 a year, the project requires a new plant with total cost of $1,000,000,which will depreciate in the next five years. A new line will require additional net investment in inventory, and receivable in the amount of $200,000. Assume no need for investment in building and land project. The firm's marginal tax rate is 35%, capital cost is 10%
1. Prepare statement showing the incremental cash flows for project over 8-year period.
2. Calculate payback period (P/B) and the NPV for the project.
3. Your answer for 2, do you think the project should be accepted? Why? Assume superior has a P/B (payback) policy of not accepting projects with life of over three years.
4. If the project required additional investment in land and building, how would this affect your decision?
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well,i would be happy to see your work and help you from there.[:
To calculate the incremental cash flows for the project over an 8-year period, we need to consider the following components:
1. Sales Revenue:
- Year 1: $950,000
- Year 2-8: $1,500,000 each year
2. Direct Costs (Labor and Materials):
Direct costs will be 55% of sales for each year.
3. Indirect Costs:
- Constant value of $80,000 throughout the 8-year period.
4. Depreciation:
- The new plant has a total cost of $1,000,000, and it will be depreciated over the next five years. Assuming straight-line depreciation, the yearly depreciation expense will be $1,000,000 / 5 = $200,000.
5. Net Investment in Inventory and Receivables:
The project requires an additional net investment of $200,000 in inventory and receivables.
6. Tax Rate:
- Marginal tax rate is 35%.
7. Capital Cost:
- The capital cost or discount rate is 10%.
Now, let's calculate the incremental cash flows year by year:
Year 0:
- Initial investment of $1,000,000 for the new plant.
Year 1:
- Sales Revenue: $950,000
- Direct Costs (55% of Sales): $950,000 * 0.55 = $522,500
- Indirect Costs: $80,000
- Depreciation: $200,000
- Taxable Income: ($950,000 - $522,500 - $80,000 - $200,000) = $147,500
- Taxes (35%): $147,500 * 0.35 = $51,625
- Net Income: $147,500 - $51,625 = $95,875
- Net Cash Flow: $95,875 + $200,000 (Net Investment) = $295,875
Year 2-8:
- Sales Revenue: $1,500,000
- Direct Costs (55% of Sales): $1,500,000 * 0.55 = $825,000
- Indirect Costs: $80,000
- Depreciation: $200,000
- Taxable Income: ($1,500,000 - $825,000 - $80,000 - $200,000) = $395,000
- Taxes (35%): $395,000 * 0.35 = $138,250
- Net Income: $395,000 - $138,250 = $256,750
- Net Cash Flow: $256,750
Now, let's calculate the payback period (P/B) and the Net Present Value (NPV) for the project:
Payback Period (P/B):
To calculate the payback period, we need to determine the year in which the cumulative cash inflows equal or exceed the initial investment of $1,000,000.
Cumulative Cash Flows:
Year 0: -$1,000,000 (Initial Investment)
Year 1: $295,875 (Net Cash Flow)
Year 2: $295,875 + $256,750 = $552,625
Year 3: $552,625 + $256,750 = $809,375
The payback period is between Year 2 and Year 3, as the cumulative cash inflows exceed the initial investment during Year 3.
Net Present Value (NPV):
NPV is the sum of the present values of all cash flows, discounted at the capital cost rate of 10%.
NPV = (-$1,000,000) + ($295,875 / (1+0.1)^1) + ($552,625 / (1+0.1)^2) + ($809,375 / (1+0.1)^3) + ($256,750 / (1+0.1)^4) + ($256,750 / (1+0.1)^5) + ($256,750 / (1+0.1)^6) + ($256,750 / (1+0.1)^7) + ($256,750 / (1+0.1)^8)
Calculating the NPV will give you the value that determines the acceptability of the project.
After calculating the payback period and NPV, we can determine whether the project should be accepted or not.
Based on the given information that the company has a payback policy of not accepting projects with a life of over three years, and the payback period for this project is between Year 2 and Year 3, we can conclude that the project should be accepted.
If the project required additional investment in land and building, it would affect the decision by increasing the initial investment cost and potentially extending the payback period. This would need to be taken into consideration when evaluating the project's feasibility.
Sure! Let's break down the problem step by step and calculate the incremental cash flows, payback period, and net present value (NPV) for the project.
1. Incremental Cash Flows:
To calculate the incremental cash flows, we need to consider the cash inflows and outflows associated with the project over an 8-year period.
Year 1:
Sales: $950,000
Direct costs labor and materials: 55% of sales = 0.55 * $950,000
Indirect costs: $80,000
Depreciation: $1,000,000/5 (over 5 years)
Net investment in inventory and receivables: $200,000
Years 2-8:
Sales: $1,500,000
Direct costs labor and materials: 55% of sales = 0.55 * $1,500,000
Indirect costs: $80,000
Depreciation: $1,000,000/5 (over 5 years)
To calculate the incremental cash flows, subtract the total costs (direct costs, indirect costs, depreciation) from the sales for each year, and add the net investment in inventory and receivables for the first year.
2. Payback Period (P/B) and NPV:
To calculate the Payback Period, determine how long it takes for the initial investment to be recovered from the annual cash flows. Sum up the cash flows from each year until the cumulative cash flow exceeds the initial investment.
To calculate the NPV, we discount the cash flows to present value using the capital cost rate of 10%. Then sum up the discounted cash flows and subtract the initial investment.
3. Decision:
If the payback period is less than three years and the NPV is positive, then the project should be accepted. If the payback period is greater than three years or the NPV is negative, then the project should not be accepted.
4. Land and Building Investment:
If the project requires additional investment in land and building, you need to consider the cash outflows associated with this investment in the incremental cash flows. Calculate the costs, depreciation, payback period, and NPV including the additional investment.
Let me know if you need further assistance with the calculations!