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 1.07 million bottles; a probability of 0.38 that consumers will find the smell acceptable and annual sales will be 170,000 bottles; and a probability of 0.10 that consumers will find the smell unpleasant and annual sales will be only 53,000 bottles. The selling price is $38, and the variable cost is $10 per bottle. Fixed production costs will be $1.03 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?

Annual incremental cash flows $_______

Explanation / Answer

Expected sales = 0.52*1070000 + 0.38*170000 + 0.1*53000 = 626300

Revenue = Sales * Price = 626300*38 = 23799400

Variable cost = Sales * VC = 626300*10 = 6263000

Fixed cost = 1030000 ,

Depreciation = 1150000

Earnings before tax = Revenue - VC - FC - Depreciation

= 23799400 - 6263000 - 1030000 - 1150000

= 20993100

40% tax = 0.4*20993100 = 8397240

Profit After Tax (PAT) = EBT - tax

   = 20993100 - 8397240

= 12595860

Annual incremental cash flows = PAT + depreciation

   = 12595860 + 1150000

   = 13745860 = 13.74586 million

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