XYZ Corporation is considering a new product line. They believe the new product

Question

XYZ Corporation is considering a new product line. They believe the new product can be sold for $10 per unit and will have the following demand over the next 3 years: 10,000 units in year 1, 15,000 in year 2 and 17,000 in year three. The incremental costs of these products will consume 50% of the sale price. The new line will require a machine be purchased today for $60,000 and depreciated using the straight line method over the life of the machine with a salvage value of zero. The project will utilize $30,000 in net working capital and the company’s tax rate is 30%. Which of the following are true regarding the project’s relevant cash flows for year 0, 1, 2, 3.

Select one:

a. I, II & III are correct

b. III. The company’s cash flow in year 3 is 65,500

c. II & III are correct

d. II. The company’s cash flow in year 1 is $41,000

e. I. The company’s year zero cash flow is (-$60000)

Explanation / Answer

d. II. The company’s cash flow in year 1 is $41,000. This is because they have not considered invt in working capital while computing cash flows as shown below.

Particulars Year 0   Year1 Year 2 Year 3 No of Units                10,000.00                15,000.00                17,000.00 SP per unit                        10.00                        10.00                        10.00                        10.00 VC per unit                           5.00                           5.00                           5.00                           5.00 Cont per unit(SP-VC)                           5.00                           5.00                           5.00                           5.00 Total Cont(Cont per Unit*no of units                               -                  50,000.00                75,000.00                85,000.00 Depreciation                20,000.00                20,000.00                20,000.00 Net income                30,000.00                55,000.00                65,000.00 Tax@30%                  9,000.00                16,500.00                19,500.00 Income after Tax                21,000.00                38,500.00                45,500.00 Depreciation                20,000.00                20,000.00                20,000.00 Cash Flows after tax                               -                  41,000.00                58,500.00                65,500.00 Investment in WC and realising on Disinvestment              (30,000.00)                30,000.00 Purchase of Machine              (60,000.00) Net Cash Flows              (90,000.00)                41,000.00                58,500.00                95,500.00 Life in Years                           3.00 Cost of Machine                60,000.00 Depreciation = 60,000/3                20,000.00 Tax savings on deprciation@30%                  6,000.00

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