Question

REX Inc. currently has one product, low-priced stoves. REX Inc. has decided to sell a new line of medium-priced stoves. Sales revenues for the new line of stoves are estimated at $60 million a year. Variable costs are 90% of sales. The project is expected to last 10 years. Also, non-variable costs are 2,500,000 per year. The company has spent $1,000,000 in research and a marketing study that determined the company will lose (cannibalization) $2.8 million in sales a year of its existing low-priced stoves. The production variable cost of the existing low-priced stoves is $1.5 million a year. The plant and equipment required for producing the new line of stoves costs $15,000,000 and will be depreciated down to zero over 30 years using straight-line depreciation. It is expected that the plant and equipment can be sold (salvage value) for $10,00,000 at the end of 10 years. The new stoves will also require today an increase in net working capital of $3.500,000 that will be returned at the end of the project. The tax rate is 20 percent and the cost of capital is 10%.

1. What is the initial outlay (IO) for this project?

2. What is the annual Earnings before Interests, and Taxes (EBIT) for this project?

3. What is the annual net operating profits after taxes (NOPAT) for this project?

4. What is the annual incremental net cash flow (operating cash flow: OCF) for this project?

5. What is the remaining book value for the plant at equipment at the end of the project?

6. What is the cash flow due to tax on salvage value for this project?

7.What is the project's cash flow for year 10 for this project?

8. What is the Net Present Value (NPV) for this project?

Answer 1

Date Page Initial Outter of the protect lont and equipment Cost t Incocese is working Capital 15ooooo0 Lt 3500ooo $ 18500000 lulation of annual Earnings before Interyt and Toxes i.e, EBIT : 7 les 60,000,000 7 (54,000,000) less Les Noriable → Depreciation (25ooooo (500ooo) EBIT > $ 3000000 (3) NOPAT ) 3000000 X (1- tox rete 3000006 X (1-0.22 2400000 = 1 I Olerating the flow for this project = NOPAT + Depreciation - After tax Cash flow reduced of existing stoves 940oooot sooooo - Drempesta (280000o- 1500000 (1-0.20) $ 1860000 Book Value of Plant at the end of Project = Cost - depreciation of 3 Veer=15000000 - 50.000X3 = $ 13500000