Use the following information for questions in Problem 3 Aft

Use the following information for questions in Problem 3: After reading a demographic study on the habits and modern lifestyles of the American public, TI Inc. decided launching a new product, Gizmo ™. TI’s CEO has asked you to determine whether or not to go ahead with the introduction of a new product. You have the following information: • Most of the numbers for your estimates come from a study by marketing consultant that you received two months ago. The consulting fee was $80,000. • You will locate the production line for the product in a currently unused building with a current after-tax market value of $600,000. The warehouse has already been depreciated so its book value is zero. • The new equipment you must buy will cost $900,000. The equipment will be depreciated on a straight line basis over 10 years to zero. • You have just received the results of a marketing survey that indicates that revenues from sale of Gizmo ™ will be $650,000 per year for 10 years. • Variable costs will be 40% of sales per year. • Fixed costs will be $170,000 per year. • It is expected that at the end of year 10 you can sell the warehouse and equipment for $120,000. • TI’s marginal tax rate is 30%. a) What is the appropriate amount to use as the initial cash flow (CFo)? b) What is the appropriate amount to use as the annual operating cash flows from the project (OCF)? c) Determine the after-tax salvage value of the project (the cash flow at the end of the project that comes from the sale of the project’s assets

Solution

1-

Initial cash inflow

cost of machine

900000

2-

Year

sales

less variable cost -40% of sales

Less fixed cost

EBIT

less tax -30%

after tax profit

add depreciation

operating cash flow

add after tax sale proceed of equipment and warehouse = sale proceeds*(1-tax rate)

net operating cash flow

1

650000

260000

170000

220000

66000

154000

90000

244000

0

244000

2

650000

260000

170000

220000

66000

154000

90000

244000

244000

3

650000

260000

170000

220000

66000

154000

90000

244000

244000

4

650000

260000

170000

220000

66000

154000

90000

244000

244000

5

650000

260000

170000

220000

66000

154000

90000

244000

244000

6

650000

260000

170000

220000

66000

154000

90000

244000

244000

7

650000

260000

170000

220000

66000

154000

90000

244000

244000

8

650000

260000

170000

220000

66000

154000

90000

244000

244000

9

650000

260000

170000

220000

66000

154000

90000

244000

244000

10

650000

260000

170000

220000

66000

154000

90000

244000

84000

328000

3-

after tax cash flow from sale of equipment and warehouse

sale proceeds*(1-tax rate)

120000*(1-.3)

84000

1-	Initial cash inflow
	cost of machine		900000
2-	Year	sales	less variable cost -40% of sales	Less fixed cost	EBIT	less tax -30%	after tax profit	add depreciation	operating cash flow	add after tax sale proceed of equipment and warehouse = sale proceeds*(1-tax rate)	net operating cash flow
	1	650000	260000	170000	220000	66000	154000	90000	244000	0	244000
	2	650000	260000	170000	220000	66000	154000	90000	244000		244000
	3	650000	260000	170000	220000	66000	154000	90000	244000		244000
	4	650000	260000	170000	220000	66000	154000	90000	244000		244000
	5	650000	260000	170000	220000	66000	154000	90000	244000		244000
	6	650000	260000	170000	220000	66000	154000	90000	244000		244000
	7	650000	260000	170000	220000	66000	154000	90000	244000		244000
	8	650000	260000	170000	220000	66000	154000	90000	244000		244000
	9	650000	260000	170000	220000	66000	154000	90000	244000		244000
	10	650000	260000	170000	220000	66000	154000	90000	244000	84000	328000
3-	after tax cash flow from sale of equipment and warehouse	sale proceeds*(1-tax rate)	120000*(1-.3)	84000