Ralph’s Bow Works (RBW) is planning to add a new line of bow ties that will requ
ID: 2725883 • Letter: R
Question
Ralph’s Bow Works (RBW) is planning to add a new line of bow ties that will require the acquisition of a new knitting and tying machine. The machine will cost $1 million. It is classified as a 7-year MACRS asset and will be depreciated as such. Interest costs associated with financing the equipment purchase are estimated to be $50,000 per year. The expected salvage value of the machine at the end of 10 years is $50,000. The decision to add the new line of bow ties will require additional net working capital of $50,000 immediately, $25,000 at the end of year 1, and $10,000 at the end of year 2. RBW expects to sell $300,000 worth of the bow ties during each of the 10 years of product life. RBW expects the sales of its other ties to decline by $25,000 (in year 1) as a result of adding this new line of ties. The lost sales level will remain constant at $25,000 over the 10-year life of the proposed project. The cost of producing and selling the ties is estimated to be $50,000 per year. RBW will realize savings of $5,000 each year because of lost sales on its other tie lines. The marginal tax rate is 40 percent. (Hint: See Appendix 9A for information on MACRS depreciation.) Compute the net investment (year 0) and the net cash flows for years 1 and 10 for this project. •17. Bratton Stone Works is considering an expansion proposal that will require an out- lay of $1 million for land and $5 million for equipment.
Explanation / Answer
Net Investemnt at year (0) => 1000000 +50000 => $1050000
Net cash flows at year 1 => Working capital + sales net of tax + tax sheild on dep + tax sheils on interest and expense + tax sheid on loss sales
=> -25000 + (300000 * 60%) + (142857 * 40%) + (100000 * 40%) + ((25000 -5000) * 40%)
Net cash flows at year 1 => $260142.8
Net cash flows at year 10 => sales net of tax +tax sheils on interest and expense + tax sheid on loss sales + net of tax on working capital and salvage value
=> (300000 * 60%) + + (100000 * 40%) + ((25000 -5000) * 40%) +( (50000 + 85000) *60%)
Net cash flows at year 10 => $309000
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