Burr Habit Corporation is considering a new product line. The company currently
ID: 2770061 • Letter: B
Question
Burr Habit Corporation is considering a new product line. The company currently manufactures several lines of snow skiing apparel. The new products, insulated ski shorts, are expected to generate sales less cost of goods sold of $1 million per year for the next five years. They expect that during this five year period, they will lose about $250,000 per year in sales less cost of goods sold on their existing lines of longer ski pants as a result of the introduction of the new product line. The new line will require no additional equipment or space in the plant and can be produced in the same manner as the existing apparel products. The new project will, however, require that the company spend an additional $80,000 per year on insurance in case customers sue for frostbite. Also, a new marketing director would be hired to oversee the line at $45,000 per year in salary and benefits. Because of the different construction of the shorts, an increase in inventory of 3,800 would be required initially. If the marginal tax rate is 30%, compute the incremental after tax cash flows per year for years 1-5.
A) $434,500 per year B) $625,000 per year C) $187,500 per year D) $437,500 per year
Please show work
Explanation / Answer
Cash flow of new project is calculated in table below:
Increase in sale minus COGS
$1,000,000
Less
Decrease in sale minus COGS of another product
$250,000
Less
Insurance
$80,000
Less
Market director Salary
$45,000
Net cash Flow before tax
$625,000
Less
Tax expense @30%
$187,500
Incremental after tax cash flows per year for years 1-5.
$437,500
Hence, net incremental after tax cash flows per year for years 1-5 is $437,500.
Increase in sale minus COGS
$1,000,000
Less
Decrease in sale minus COGS of another product
$250,000
Less
Insurance
$80,000
Less
Market director Salary
$45,000
Net cash Flow before tax
$625,000
Less
Tax expense @30%
$187,500
Incremental after tax cash flows per year for years 1-5.
$437,500
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