Consider the following expansion opportunity for Tina\'s facial cream. Tina is c
ID: 2698086 • Letter: C
Question
Consider the following expansion opportunity for Tina's facial cream. Tina is considering expansion into a new line of anti aging facial cream. Tina has paid $100,000 for a marketing study to assist in this and other potential valuations. The study indicates that the new product will have sales of $1,900,000 per year for each of the next 6 years. However, existing product line sales will be reduced by $200,000 per year. Manufacturing plant and equipment will cost $1,100,000 and will be depreciated on the straight-line method to zero with a 10% market value at the end of 6 years. Annual fixed costs are projected at $160,000 per year and variable costs are projected at 60% of sales. Also, an initial working capital outlay of $150,000 will be required which will be recaptured at the end of the 6 years. Tinas tax rate is 35% and the firm requires an18% return.
Based on the following criteria: 1. Net present Value, and 2. Internal Rate of Return, should Tina undertake this project? (Please round to the nearest dollar on all calculations) Also please show all calculations and work step by step! Thanks
Explanation / Answer
Annual post tax cash flow
Sales= 1,900,000
Less: Existin sales reduced = 200000
Total sale increased = 1,700,000
Less: variable cost = 60%*1,700,000=1,020,000
Less: Fixed Cost = 160,000
Less: depreciation = 183,333
Net profit before tax increased = 336,667
Less: tax = 117833
Net profit after tax =218,834
Add: Depreciation = 183,333
Annual post tax saving =402,167
Initial investment
Plant & Equipment = 1,100,000
Working Capital = 150,000
Intial Investment = 1,250,000
Post tax salvage value
Salvage value =1,100,000*10% = 110,000
Tax: 110,000*35% =38500
Post tax salvage value =71500
Working capital realised at the end of 6 year = 150,000
Note1:Expenses incurred on market research is not relevant cost it is already incurred
Note2: variable cost is calculated on net increased sale assuming same % of variable cost are incurred in existing product line
1)Net present Value = 402,167 PVIFA(18%,6) + 71,500PVIF(18%,6) + 150,000PVIF(18%,6) - 1,250,000 = $238,670.91
and 2. Internal Rate of Return= 24.835%
Tina should undertake this project becuase its NPV is positive or IRR is greater than required rate of return
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