Question

Finco Inc. manufactures financial calculators. The company is deciding whether to introduce a new calculator. This calculator will sell for $85. The company feels that sales will be 13,500, 13,900, 14,000, 14,200, and 13,000 units per year for the next 5 years. Variable costs will be 30% of sales, and fixed costs are $250,000 per year. The firm hired a marketing team to analyze the viability of the product and the marketing analysis cost $1,000,000. The company plans to use a vacant warehouse to manufacture and store the financial calculators. Based on a recent appraisal the warehouse and the property is worth $2.2 million on an after tax basis. If the company does not sell the property today then it will sell the property 5 years from today at the currently appraised value. This project will require an injection of net working capital at the on set of the project in the amount of $50,000. This net working capital will be fully recovered at the end of the project. The firm will need to purchase some equipment in the amount of $500,000 to produce the new calculators. The machine has a 7 year life and will be depreciated using the straight-line method. At the end of the project, the anticipated market value of the machine is $150,000. The firm requires an 8% return on its investment and has a tax rate of 21%. Calculate the cash flow from assets at the end of year 5. (Round to two decimals)

Answer 1

Calculation of depreciation per year using straight line method
Depreciation expense	(Cost - Salvage value)/Useful life
Depreciation expense	(500000-150000)/7
Depreciation expense	$50,000
Calculation of book value of machine at end of 5th year
Cost	$500,000
Accumulated depreciation	-$250,000	50000*5
Book value	$250,000
Calculation of after tax salvage value at end of year 5
Sale proceeds	$150,000.00
Less: Book value	$250,000.00
Loss on sale	-$100,000.00
Tax benefit on loss	$21,000.00	100000*21%
After tax salvage value	$171,000.00	(150000+21000)
Cash flow from assets at the end of year 5 is $171,000.