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

Question

A beauty product compant is developing a new fragrance named Happy Forever. There is a probability of a 0.5 that consumers will love Happy Forever, and in this case, annual sales will be 1 million bottles, a probability of 0.4 that consumers will find the smell acceptable and annual sales will be 200,000 bottles; and a probability of 0.1 that consumers will find the smell unpleasant and annual sales will be only 50,000 bottles. The selling price is at $38, and the variable cost is $8 per bottle. Fixed production cost will be $1 million per year, and depreciation will be $1.2 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

Annual sales in bottles 1000000 200000 50000 Sales revenue 38000000 7600000 1900000 Variable cost 8000000 1600000 400000 Fixed cost 1000000 1000000 1000000 Depreciation 1200000 1200000 1200000 EBIT 27800000 3800000 -700000 Tax at 40% 11120000 1520000 -280000 NOPAT 16680000 2280000 -420000 Add: Depreciation 1200000 1200000 1200000 OCF 17880000 3480000 780000 Less: Capital expenditure and Change in NWC 0 0 0 FCF 17880000 3480000 780000 ` Probability 0.5 0.4 0.1 FCF * Probability 8940000 1392000 78000 10410000 Expected annual incremental after-tax free cash flows from the new fragrance 10410000 Answer

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