Company S desires to add a new line to its product mix. For this purpose the analysis of capital budgeting was conducted by person S an MBA graduate. The invoice price of the machinery is $200,000 approximately and $10,000 shipping charges are required. Installation charges are $30,000. The machinery has a 4 years’ life with a salvage value of $25000. The new line leads to increase the sales of 1,250 units each year of 4 years and cost of $100 per unit in first year. The units are sold for $200 in the 1 st year. It results to an increase in company’s net working capital by 12% value of sales. Company’s tax rate is 40% and risk adjusted cost of capital or weighted average cost of capital for an average project is 10%. Characters in the case: Company S Person S To compute: The salvage cash flow after tax.

Question

The Fortune Company is considering a new investment. Financial projections for the investment are tabulated below. The corporate tax rate is 24 percent. Assume all sales revenue is received in cash, all operating costs and income taxes are paid in cash, and all cash flows occur at the end of the year. All net working capital is recovered at the end of the project. Year 0 Year 1 Year 2 Year 3 Year 4 Investment $ 28,000 Sales revenue $ 14,500 $ 15,000 $ 15,500 $ 12,500 Operating costs 3,100 3,200 3,300 2,500 Depreciation 7,000 7,000 7,000 7,000 Net working capital spending 340 390 440 340 ?

Answer 1

Question

Chapter 11, Problem 6MC

Summary Introduction

Case summary:

Company S desires to add a new line to its product mix. For this purpose the analysis of capital budgeting was conducted by person S an MBA graduate. The invoice price of the machinery is $200,000 approximately and $10,000 shipping charges are required. Installation charges are $30,000. The machinery has a 4 years’ life with a salvage value of $25000.

The new line leads to increase the sales of 1,250 units each year of 4 years and cost of $100 per unit in first year. The units are sold for $200 in the 1^st year.

It results to an increase in company’s net working capital by 12% value of sales. Company’s tax rate is 40% and risk adjusted cost of capital or weighted average cost of capital for an average project is 10%.

Characters in the case:

Company S

Person S

To compute: The salvage cash flow after tax.

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