Question

Given the soaring price of gasoline, Ford is considering introducing a new production line of gas-electric hybrid sedans. The expected annual unit sales of the hybrid cars is 31,000; the price is $25,000 per car. Variable costs of production are $11,000 per car. The fixed overhead including salary of top executives is $80 million per year. However, the introduction of the hybrid sedan will decrease Ford’s sales of regular sedans by 11,000 cars per year; the regular sedans have a unit price of $20,000, a unit variable cost of $12,000, and fixed costs of $250,000 per year. Depreciation costs of the production plant are $46,000 per year. The marginal tax rate is 40 percent. What is the incremental annual cash flow from operations?

Incremental annual cash flow from operations

$

Answer 1

Calculation of incremental annual cash flow from operations is shown below
Incremental sales revenue	$775,000,000	31000*25000
Incremental variable costs	-$341,000,000	31000*11000
Decrease in sales of regular sedan	-$220,000,000	11000*20000
Decrease in variable costs	$132,000,000	11000*12000
Depreciation	-$46,000
Increase in EBIT	$345,954,000
Taxes @ 40%	$138,381,600
Add: Depreciation	$46,000
Incremental annual cash flow	$138,427,600
Fixed costs would remain same irrespective of introduction of new line and thus is not relevant for decision making.