A company is considering manufacturing new elliptical trainers. This company did

Question

A company is considering manufacturing new elliptical trainers. This company did a marketing research 2 yrs ago, after paying $750,000 of consulting fees and they found that the market is ripe for such a new product. The company feels that they can sell 5,000 of these elliptical trainers per year for 5 yrs (after which time this project is expected to shut down by).

The elliptical trainers would sell for $2,000 each and have a variable cost of $500 each. The annual fixed costs associated with production would be $1,000,000. In addition, there would be a $5,000,000 initial expenditure associated with the purchase of new production equipment.

It is assumed that this initial expenditure will be depreciated using the straight- line method down to zero over 5 yrs. This project will also require a one-time initial investment of $1,000,000 in working capital associated with inventory. The introduction of this new elliptical trainer will reduce the sales of an existing training machine that the company currently sells.

The company estimates that $250,000 per year before tax basis will be lost on this existing training machine if the new elliptical trainer is introduced. At the end of the 5th yr, the company estimates selling its production equipment for $150,000. Finally, assume that the firm

Explanation / Answer

Answer:

CF0= Initial Cash Flow =

Initial Expenditure to purchase new Production Equipment + Change in Working Capital

Hence, CF0 = 5,000,000 + 1,000,000 = $6,000,000 ,

As this is an outlay, it will be $-6,000,000.

CF1 = Sales

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