Chip’s Home Brew Whiskey management forecasts that if the firm sells each bottle of Snake-Bite for $20, then the demand for the product will be 15,000 bottles per year, whereas sales will be 91 percent as high if the price is raised 18 percent. Chip’s variable cost per bottle is $10, and the total fixed cash cost for the year is $100,000. Depreciation and amortization charges are $20,000, and the firm has a 30 percent marginal tax rate. Management anticipates an increased working capital need of $3,000 for the year. What will be the effect of the price increase on the firm’s FCF for the year?
Chip’s Home Brew Whiskey management forecasts that if the firm sells each bottle of Snake-Bite for $20, then the demand for the product will be 15,000 bottles per year, whereas sales will be 87 percent as high if the price is raised 17 percent. Chip’s variable cost per bottle is $10, and the total fixed cash cost for the year is $100,000. Depreciation and amortization charges are $20,000, and the firm has a 30 percent marginal tax rate. Management anticipates an increased working capital need of $3,000 for the year. What will be the effect of the price increase on the firm’s FCF for the year?
To determine the effect of the price increase on the firm's Free Cash Flow (FCF) for the year, we need to calculate the various components of the FCF.
First, let's calculate the total revenue for the year if the price is set at $20 per bottle:
Total Revenue = Price per bottle * Quantity
Total Revenue = $20 * 15,000
Total Revenue = $300,000
Next, let's calculate the new quantity of bottles sold if the price is increased by 18%:
New Quantity = 91% * 15,000 bottles
New Quantity = 0.91 * 15,000
New Quantity = 13,650
Now, let's calculate the new price per bottle after the 18% increase:
New Price = $20 + (18% * $20)
New Price = $20 + (0.18 * $20)
New Price = $20 + $3.60
New Price = $23.60
Now, let's calculate the new total revenue with the increased price:
New Total Revenue = New Price * New Quantity
New Total Revenue = $23.60 * 13,650
New Total Revenue = $321,540
Next, let's calculate the Total Variable Cost:
Total Variable Cost = Variable Cost per bottle * Quantity
Total Variable Cost = $10 * 15,000
Total Variable Cost = $150,000
Then, we calculate the new Total Variable Cost with the new quantity:
New Total Variable Cost = Variable Cost per bottle * New Quantity
New Total Variable Cost = $10 * 13,650
New Total Variable Cost = $136,500
Now, let's calculate the Total Costs:
Total Costs = Total Fixed Cash Costs + Total Variable Cost
Total Fixed Cash Costs = $100,000
Total Costs = $100,000 + $150,000
Total Costs = $250,000
New Total Costs = Total Fixed Cash Costs + New Total Variable Cost
New Total Costs = $100,000 + $136,500
New Total Costs = $236,500
Next, let's calculate the Earnings Before Interest and Taxes (EBIT):
EBIT = Total Revenue - Total Costs
EBIT = $300,000 - $250,000
EBIT = $50,000
New EBIT = New Total Revenue - New Total Costs
New EBIT = $321,540 - $236,500
New EBIT = $85,040
Next, let's calculate the Earnings Before Tax (EBT):
EBT = EBIT - Depreciation and Amortization
Depreciation and Amortization = $20,000
EBT = $50,000 - $20,000
EBT = $30,000
New EBT = New EBIT - Depreciation and Amortization
New EBT = $85,040 - $20,000
New EBT = $65,040
Then, let's calculate the Taxes:
Taxes = EBT * Marginal Tax Rate
Marginal Tax Rate = 30%
Taxes = $30,000 * 30%
Taxes = $9,000
New Taxes = New EBT * Marginal Tax Rate
New Taxes = $65,040 * 30%
New Taxes = $19,512
Now, let's calculate the Net Income:
Net Income = EBT - Taxes
Net Income = $30,000 - $9,000
Net Income = $21,000
New Net Income = New EBT - New Taxes
New Net Income = $65,040 - $19,512
New Net Income = $45,528
Finally, let's calculate the Free Cash Flow (FCF):
FCF = Net Income + Depreciation and Amortization - Change in Working Capital
Change in Working Capital = $3,000
FCF = $21,000 + $20,000 - $3,000
FCF = $38,000
New FCF = New Net Income + Depreciation and Amortization - Change in Working Capital
New FCF = $45,528 + $20,000 - $3,000
New FCF = $62,528
Therefore, the effect of the price increase on the firm's FCF for the year is an increase from $38,000 to $62,528.