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 0.52 that consumers will love Happy Forever, and in this case, annual sales will be 1.10 million bottles; a probability of 0.40 that consumers will find the smell acceptable and annual sales will be 171,000 bottles; and a probability of 0.08 that consumers will find the smell unpleasant and annual sales will be only 55,000 bottles. The selling price is $36, and the variable cost is $9 per bottle. Fixed production costs will be $1.05 million per year, and depreciation will be $1.17 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 :[.52*1,100,000]+[.40*171,000]+[.08*55,000]

            = 572,000+ 68,400+ 4400

           = 644,800 units

Net Income After tax :[UNits sold (price-variable cost)-Fixed cost-Depreciation][1-Tax]

       =[644800(36-9]-1,050,000-1,170,000][1-.40]

       = [(644800*27) - 2,220,000]*.60

        = [17,409,600-2,220,000]*.60

         = 15,189,600*.60

              = 9,113,760

expected annual incremental after-tax free cash flows from the new fragrance:Net income after tax+depreciation(non cash)

     = 9,113,760+1,170,000

     = $ 10,283,760

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