Below is an Income and cash flow statements for a new product model that managem

Question

Below is an Income and cash flow statements for a new product model that management has approved.   Two scenarios besides the original forecast are listed below along with the probability of each occurring. The model uses links to the Original forecast in the data block only. a Determine the expected worth and expected internal rate of return for the three possible scenarios. b Write a sentence or two recommendation to management concerning the answer to part a. Original Forecast Forecast X Forecast Y Probability of occurrence 40% 25% 35% Sales quantity in Year 1 40,000 350,000 45,000 Annual Sales Increase 20% 10% 25% Unit Price $38.88 $38.88 $38.88 COGS each $12.50 $14.00 $12.00 S.G.& A. $800,000 $800,000 $800,000 Income tax rate 35% 35% 35% MARR 15% 15% 15% Investment $2,000,000 $2,500,000 $1,750,000 Years 0 1 2 3 4 5 6 Sales Quantity Forecast 40,000 48,000 57,600 69,120 82,944 99,533 Depreciation 5-year MACRS 20.00% 32.00% 19.20% 11.52% 11.52% 5.76% Income Statement 0 1 2 3 4 5 6 Sales revenue $1,555,200 $1,866,240 $2,239,488 $2,687,386 $3,224,863 $3,869,835 Cost of goods sold ($500,000) ($600,000) ($720,000) ($864,000) ($1,036,800) ($1,244,160) Gross Margin $1,055,200 $1,266,240 $1,519,488 $1,823,386 $2,188,063 $2,625,675 General, Sales and Admin. ($800,000) ($800,000) ($800,000) ($800,000) ($800,000) ($800,000) Depreciation ($400,000) ($640,000) ($384,000) ($230,400) ($230,400) ($115,200) EBIT ($144,800) ($173,760) $335,488 $792,986 $1,157,663 $1,710,475 Income tax $50,680 $60,816 ($117,421) ($277,545) ($405,182) ($598,666) Net income ($94,120) ($112,944) $218,067 $515,441 $752,481 $1,111,809 Cash Flow Statement Net Income ($94,120) ($112,944) $218,067 $515,441 $752,481 $1,111,809 Add depreciation $400,000 $640,000 $384,000 $230,400 $230,400 $115,200 Investment (2,000,000)                Change in Working Capital ($155,520) ($31,104) ($37,325) ($44,790) ($53,748) ($64,497) Cash flow ($2,000,000) $150,360 $495,952 $564,742 $701,051 $929,133 $1,162,512 Present Worth = IRR $242,443 18.39% Below is an Income and cash flow statements for a new product model that management has approved.   Two scenarios besides the original forecast are listed below along with the probability of each occurring. The model uses links to the Original forecast in the data block only. a Determine the expected worth and expected internal rate of return for the three possible scenarios. b Write a sentence or two recommendation to management concerning the answer to part a. Original Forecast Forecast X Forecast Y Probability of occurrence 40% 25% 35% Sales quantity in Year 1 40,000 350,000 45,000 Annual Sales Increase 20% 10% 25% Unit Price $38.88 $38.88 $38.88 COGS each $12.50 $14.00 $12.00 S.G.& A. $800,000 $800,000 $800,000 Income tax rate 35% 35% 35% MARR 15% 15% 15% Investment $2,000,000 $2,500,000 $1,750,000 Years 0 1 2 3 4 5 6 Sales Quantity Forecast 40,000 48,000 57,600 69,120 82,944 99,533 Depreciation 5-year MACRS 20.00% 32.00% 19.20% 11.52% 11.52% 5.76% Income Statement 0 1 2 3 4 5 6 Sales revenue $1,555,200 $1,866,240 $2,239,488 $2,687,386 $3,224,863 $3,869,835 Cost of goods sold ($500,000) ($600,000) ($720,000) ($864,000) ($1,036,800) ($1,244,160) Gross Margin $1,055,200 $1,266,240 $1,519,488 $1,823,386 $2,188,063 $2,625,675 General, Sales and Admin. ($800,000) ($800,000) ($800,000) ($800,000) ($800,000) ($800,000) Depreciation ($400,000) ($640,000) ($384,000) ($230,400) ($230,400) ($115,200) EBIT ($144,800) ($173,760) $335,488 $792,986 $1,157,663 $1,710,475 Income tax $50,680 $60,816 ($117,421) ($277,545) ($405,182) ($598,666) Net income ($94,120) ($112,944) $218,067 $515,441 $752,481 $1,111,809 Cash Flow Statement Net Income ($94,120) ($112,944) $218,067 $515,441 $752,481 $1,111,809 Add depreciation $400,000 $640,000 $384,000 $230,400 $230,400 $115,200 Investment (2,000,000)                Change in Working Capital ($155,520) ($31,104) ($37,325) ($44,790) ($53,748) ($64,497) Cash flow ($2,000,000) $150,360 $495,952 $564,742 $701,051 $929,133 $1,162,512 Present Worth = IRR $242,443 18.39%

Explanation / Answer

a) The expected worth is $242,443 and Expected internal rate of return is 18.39%.

b) As per the analysis to part-a, the present worth is $242,443 because the sales units are less and hence the sales revenue has decreased. Due to this, the net income and the resulting operating cash flows were decreased. As the discount rate is 15%,the present value of cash flows would become low. Hence, the present worth would be low. This is the reason why the IRR is little more than the MARR of 15%.

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