Question

Waldo Entertainment Products, Inc. is negotiating with Disney for the rights to manufacture and sell superhero-themed toys for a three-year period. At the end of year 3, Waldo plans to liquidate the assets from the project. In addition to the facts and assumptions below, assume that working capital must be invested immediately (in year 0) and will be fully recovered at the end of year 3, and that no incremental overhead expense will be incurred from the project. Note that the difference between the selling price of the equipment at the end of year 3 and the equipment's book value at the time of the sale is a taxable gain. Identify the relevant cash flows, then calculate the investment’s net present value, benefit-cost ratio, and internal rate of return.​​​​​​​

Waldo Entertainment Products, Inc. is negotiating with Disney for the rights to manufacture and sell superhero-themed toys for a three-year period. At the end of year 3, Waldo plans to liquidate the assets from the project. In addition to the facts and assumptions below, assume that working capital must be invested immediately in year 0) and will be fully recovered at the end of year 3, and that no incremental overhead expense will be incurred from the project. Note that the difference between the selling price of the equipment at the end of year 3 and the equipment's book value at the time of the sale is a taxable gain. Identify the relevant cash flows, then calculate the investment's net present value, benefit-cost ratio, and internal rate of return. Facts and assumptions ($ thousands) Marketing research costs, to date $45,000 Initial cost of new equipment $250,000 Expected life of equipment (years) Salvage value $50,000 Depreciation method Straight-line Selling price of new equipment at the end of year 3 $150,000 Incremental annual sales (years 1 through 3) $350,000 Incremental annual production costs $170,000 Incremental annual selling and administrative expenses $55,000 Current annual overhead costs $200,000 Tax rate 25% Working capital required Increase in A/R $60,000 Increase in Inventories $40,000 Increase in A/P $25,000 Minimum required rate of return 14% Year 2 Investment in equipment Investment in net working capital Sales Cost of sales Gross profit Selling and administrative expenses Operating income Depreciation Income before tax Tax Income after tax Free cash flow Net present value Payback period Accounting rate of return Benefit-cost ratio Internal rate of return

Answer 1

Step 1:Calculation of Working capital requirement.

Working Capital= (Account Receivable+Inventories-Account Payable)

= ($60000+$40000-$25000)

=$75000.

Step 2:Calculation of depreciation.

Depreciation=Initial Cost-Salvage Value / useful Life of asset

=($250000-$50000)/5 Years.

=$40,000

Step 3:Final Answer.

1.Investment

Purticulers	0	1	2	3
Initial Investment	-$250,000	0	0	$150000
Working Capital Required(Note-1)	-$75000	0	0	$75,000
Total	-$325,000	0	0	$225,000

2 Profitability Statement

Purticulers	0	1	2	3
Sales		350000	350000	350000
Less:Cost Of goods Sold		170000	170000	170000
Gross Profit		180000	180000	180000
Less:Selling and administative Expenses		55000	55000	55000
Operating Income		125000	125000	125000
Depreciation(note 2)		40000	40000	40000
Income Before Tax		85000	85000	85000
Less:TAx@25%		21250	21250	21250
Income after TAx		63750	63750	63750
Free Cash Flow (See working Note 4)	-325000	103750	103750	328750
Discounting factor@14%	1	0.8772	0.7695	0.6749
Discounted Cash Flow	-325000	91009.5	79835.625	221873.375

Note 4:Free Cash Flow= (Cash Flow after tax+Depreciation-Cash Outflow+Cash Inflow)

Note 5: Net Present Value it is sum of discounted cash flow).

=-325000+91009.5+79385.625+221873.375

=67,268.50

Note 6 :Payback Period.

=Initial Investment /Cash Flow

=$325000/$103750

=3 Years.