We are considering the introduction of a new product. Currently we are in the 34% tax bracket with a 15% discount rate. This project is expected to last five years and then, because this is somewhat of a fad project, it will be terminated. The following information describes the new project:
Cost of new plant and equipment: $ 7,900,000
Shipping and installation costs: $ 100,000
Unit sales:
Year Units Sold
1 70,000
2 120,000
3 140,000
4 80,000
5 60,000
Sales price per unit: $300/unit in years 1–4 and $260/unit in year 5.
Variable cost per unit: $180/unit
Annual fixed costs: $200,000 per year
Working capital requirements: There will be an initial working capital requirement of $100,000 just to get production started. For each year, the total investment in net working capital will be equal to 10% of the dollar value of sales for that year. Thus, the investment in working capital will increase during years 1 through 3, then decrease in year 4. Finally, all working capital is liquidated at the termination of the project at the end of year 5.
Depreciation method: Straight-line over 5 years assuming the plant and equipment have no salvage value after 5 years.
What are the incremental cash flows for the project in years 1 through 5 and how do these cash flows differ from accounting profits or earnings?
3 answers