USA Manufacturing has a rapidly growing product that needs an increase in produc

Question

USA Manufacturing has a rapidly growing product that needs an increase in production capacity to keep up with the sales increases. It has been proposed to move all production of the product offshore since the investment funds and personal resources are not available to expand the in-house capacities. Other products can use the vacated production capability so no shutdown costs will be incurred. It is expected that the forecasted revenues for this product will not be changed by this proposal. The COGS is expected to decrease and the working capital items of inventory, accounts payable, and accounts receivable will increase. It is expected the that proposal will incur an upfront investment of $250,000 that includes all upfront travel time, vendor evaluations, etc. This upfront investment will not be depreciated. The project proposal for the new product will require a buildup of $50,000 of inventory in year 0 before sales are started in year 1. Inventory is expected to be maintained at $50,000 in year 2, increased to $65,000 in year 2 and $70,000 in year 3. Accounts payable will increase by $20,000 in year 0, continue at $20,000 in year 1, and will increase to $23,000 in year 2, and to $25,000 in year 3. No change in Accounts receivable is expected. The ending value of assets created by the proposal is to be limited to the increase in working capital over the time span of the proposal. That is, there is no salvage value, etc. The working capital gain or loss should not be considered taxable. It is expected the that proposal will incur added expenses of $250,000 to implement. This includes all upfront travel time, vendor evaluations, etc. This is not depreciable and has no salvage value. The forecasted change in Net Income due to COGS and working capital changes are shown below. Prepare a Cash flow statement and evaluate the proposal using a MARR of 15%. Investment $250,000 MARR 15% Change in Net Income $40,000 $80,000 $160,000 Solution USA Manufacturing has a rapidly growing product that needs an increase in production capacity to keep up with the sales increases. It has been proposed to move all production of the product offshore since the investment funds and personal resources are not available to expand the in-house capacities. Other products can use the vacated production capability so no shutdown costs will be incurred. It is expected that the forecasted revenues for this product will not be changed by this proposal. The COGS is expected to decrease and the working capital items of inventory, accounts payable, and accounts receivable will increase. It is expected the that proposal will incur an upfront investment of $250,000 that includes all upfront travel time, vendor evaluations, etc. This upfront investment will not be depreciated. The project proposal for the new product will require a buildup of $50,000 of inventory in year 0 before sales are started in year 1. Inventory is expected to be maintained at $50,000 in year 2, increased to $65,000 in year 2 and $70,000 in year 3. Accounts payable will increase by $20,000 in year 0, continue at $20,000 in year 1, and will increase to $23,000 in year 2, and to $25,000 in year 3. No change in Accounts receivable is expected. The ending value of assets created by the proposal is to be limited to the increase in working capital over the time span of the proposal. That is, there is no salvage value, etc. The working capital gain or loss should not be considered taxable. It is expected the that proposal will incur added expenses of $250,000 to implement. This includes all upfront travel time, vendor evaluations, etc. This is not depreciable and has no salvage value. The forecasted change in Net Income due to COGS and working capital changes are shown below. Prepare a Cash flow statement and evaluate the proposal using a MARR of 15%. Investment $250,000 MARR 15% Change in Net Income $40,000 $80,000 $160,000 Solution

Explanation / Answer

Initial Investment = 250000 Year 0 1 2 3 Net Income 40000 80000 160000 Working Capital: Inventory 50000 50000 65000 70000 Accounts Receivable No change Accounts Payable 20000 20000 23000 25000 Change in working capital: Change in Inventory 0 -15000 -5000 Change in Acc Receivable 0 0 0 Change in Acc Payable 0 3000 2000 Change in Working Capital 0 -12000 -3000 No depreciation is charged. So Cash flow statement Year 1 2 3 Net income 40000 80000 160000 Add: Change in working capital 0 -12000 -3000 Cash Flows $   40,000.00 $ 68,000.00 $ 157,000.00 Initial Investment = $250,000 And MARR = 15% Therefore NPV = -$60,569.57 As the NPV is negative therefore the project should not be accepted.

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