A beauty product company is developing a new fragrance named Happy Forever. Ther

Question

A beauty product company is developing a new fragrance named Happy Forever. There is a probability of 0.49 that consumers will love Happy Forever, and in this case, annual sales will be 1.08 million bottles; a probability of 0.38 that consumers will find the smell acceptable and annual sales will be 173,000 bottles; and a probability of 0.13 that consumers will find the smell unpleasant and annual sales will be only 55,000 bottles. The selling price is $37, and the variable cost is $10 per bottle. Fixed production costs will be $1.00 million per year, and depreciation will be $1.15 million. Assume that the marginal tax rate is 40 percent. What are the expected annual incremental after-tax free cash flows from the new fragrance?

Explanation / Answer

Expected sales (units) = 0.49 x 1,080,000 + 0.38 x 173,000 + 0.13 x 55,000 = 529,200 + 65,740 + 7,150

= 602,090

Expected pre-tax profit ($) = Expected Revenue - Expected variable costs - Fixed costs - Depreciation

= (602,090 x 37) - (602,090 x 10) - 1,000,000 - 1,150,000

= 22,277,330 - 6,020,900 - 1,000,000 - 1,150,000

= 14,106,430

Expected after-tax profit ($)= = Expected pre-tax profit x (1 - tax rate) = 14,106,430 x (1 - 0.4)

= 14,106,430 x 0.6 = 8,463,858

Expected after-tax free cash flow ($) = Expected after-tax profit + Depreciation (Since it's non-cash expense)

= 8,463,858 + 1,150,000

= 9,613,858

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