?(Incremental earnings from advertising? synergies) ?Bangers, Inc. is a? start-u

Question

?(Incremental earnings from advertising? synergies) ?Bangers, Inc. is a? start-up manufacturer of? Australian-style frozen veggie pies located in San? Antonio, Texas. The company is five years old and recently installed the manufacturing capacity to quadruple its unit sales. To jump start the demand for its? products, the company founders have hired a local advertising firm to create a series of ads for its new line of meat pies. The ads will cost the firm ?$400,000 to run for one year. ? Bangers' management hopes that the advertising will produce annual sales of ?$2 million for its meat pies. ? Moreover, the? firm's management expects that sales of its veggie pies will increase by?$200,000 next year as a result of the company name recognition derived from the meat pie ad campaign. If? Bangers' operating profits per dollar of new sales revenue are 40 percent and the firm faces a 30 percent tax? bracket, what is the incremental operating profit the firm can expect to earn from the ad? campaign? Does the decision to place the ad look good from the perspective of the anticipated? profits?

________________________________________________________________________________________

The incremental operating profit the firm can expect to earn from the ad campaign for year 1 is $_____.(Round to the nearest? dollar.)

The incremental operating profit the firm can expect to earn from the ad campaign for year 2 is ?$_____.?(Round to the nearest? dollar.)

The decision to place the ad appears to be an (Acceptable or Unacceptable) ____ project since the year 1 and year 2 cash flows are significantly ( Greater or Less) ____ than the ?$400,000 initial outlay for taking the project.?(Select from the? drop-down menus.)

Explanation / Answer

Operating profit % = Operating profit/Net Sales

For year 1 Operating profit % = 40% = 0.4

0.4 = Operating profit/ 2,000,000

Incremental Operating profit for Year 1 = 2,000,000*0.4 = $800,000

For year 2, Sales = 2,000,000 + 200,000 (Veggie pies) = 2,200,000

0.4 = Operating profit/ 2,200,000

Incremental Operating profit for Year 2 = 2,200,000*0.4 = $880,000

Cash flows in year 1 = 800,00*(1-tax rate) = 800,000*(1-0.3) = 560,000

Cash flows in year 2 = 880,00*(1-tax rate) = 880,000*(1-0.3) = 616,000

The decision to place the ad appears to be an Acceptable project since the year 1 and year 2 cash flows are significantly Greater than the ?$400,000 initial outlay for taking the project

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