Question

Adams, Incorporated would like to add a new line of business to its existing retail business. The new line of business will be the manufacturing and distribution of animal feeds. This is a major capital project. Adams, Incorporated is aware you an in an MBA program and would like you to help analysis the viability of this major business venture based on the following information:
• The production line would be set up in an empty lot the company owns.
• The machinery’s invoice price would be approximately $200,000, another $10,000 in shipping charges would be required, and it would cost an additional $30,000 to install the equipment.
• The machinery has useful life of 4 years, and it is a MACRS 3-year asset.
• The machinery is expected to have a salvage value of $25,000 after 4 years of use.
• This new line of business will generate incremental sales of 1,250 units per year for 4 years at an incremental cost of $100 per unit in the first year, excluding depreciation. Each unit can be sold for $200 in the first year. The sales price and cost are expected to increase by 3% per year due to inflation.
• Net working capital would have to increase by an amount equal to 12% of sales revenues. The firm’s tax rate is 40%, and its overall weighted average cost of capital is 10%.

Required:
Construct annual incremental operating cash flow statements.

Answer 1

Answer:

machine's cost = $200,000 + $10,000 + $30,000 = $240,000

useful life of 4 years

salvage value of $25,000, depreciable value = $215,000

MACRS 3-year asset:

• 0.333 x $215,000 = $71,595
• 0.445 x $215,000 = $95,675
• 0.148 x $215,000 = $31,820
• 0.074 x $215,000 = $15,910

incremental sales of 1,250 units per year, during 4 years:

• 1,250 x $200 = $250,000
• 1,250 x $206 = $257,500
• 1,250 x $212.18 = $265,225
• 1,250 x $218.55 = $273,188

incremental COGS of 1,250 units per year, during 4 years:

• 1,250 x $100 = $125,000
• 1,250 x $103 = $128,750
• 1,250 x $106.09 = $132,613
• 1,250 x $109.27 = $136,588

net working capital increases by 12% of sales revenue = $250,000 x 12% = $30,000

WACC = 10%

tax rate = 40%

initial investment = $240,000 (machine cost) + $30,000 (working capital) = $270,000

• net cash year 1 = [($250,000 - $125,000 - $71,595) x (1 - 40%)] + $71,595 = $103,638
• net cash year 2 = [($257,500 - $128,750 - $95,675) x (1 - 40%)] + $95,675 = $115,520
• net cash year 3 = [($265,225 - $136,588 - $31,820) x (1 - 40%)] + $31,820 = $92,295
• net cash year 4 = [($273,188 - $136,588 - $15,910) x (1 - 40%)] + $15,910 = $88,324 + $25,000 (salvage value) + $30,000 (net working capital) = $143,324

to calculate the present value:

PV = $103,638/1.1 + $115,520/1.1² + $92,295/1.1³ + $143,324/1.1⁴ = $94,216 + $95,471 + $69,343 + $97,892 = $356,922

NPV = $356,922 - $270,000 = $86,922