Question

question 9 and 10

Question 9 (10 points) Kramerica Industires plans to introduce a new product to the market. Last week, Kramerica hired a marketing firm to develop a TV ad for the product. The marketing firm will develop the ad regardless of Kramerica's decision to continue the project or not. The project will require additional working capital of $300,000 which will be recovered at the conclusion of the project. The firm has spent $250,000 on R&D for this project. To launch the project Kramerica will have to invest $26 million today in plant and machinery. The plant and machinery have an economic life of 20 years and a salvage value of $4 million. The project is expected to generate sales of $9 million per year for 20 years. Of these, 20% are due to lost sales of the existing products of the company. The incremental variable costs of producing the product is $3.4m. Fixed costs are $700,000 per year. Kramerica's accountants have allocated $400,000 in managerial salaries to the project but no additional managers need to be hired. The company uses straight line depreciation. It has a marginal tax rate of 40% and a 10% cost of capital. The cash flow in year 20 (t-20) is $. 6,700,000 6,680,000 6,650,000 6,620,000 6,600,000 Question 10 (10 points) Which of the following would not be included in calculating the incremental cash flow for a project? The firm expects sales of the new product to be $5,000,000 per year Working capital will decrease by $100,000 at t-o The firm must pay $3,000,000 for equipment to produce the new drink. The firm expects sales of existing drinks to decrease by $500,000 per year because current customers will switch to the new drink. The property on which the plant will be built has bought in1950 for $10,000

Answer 1

Calculation of cash flows in year 20:

Incremental Sales = 9,000,000*80% = $7,200,000

Less: variable costs = $3,400,000

Fixed costs = $700,000

Depreciation (26 million – 4 million)/20 = $1,100,000

Income before tax = $2,000,000

Less: Tax @40% = $800,000

Income after Tax = $1,200,000

Add: Depreciation = $1,100,000

Cash flow from operations = $2,300,000

Add: Salvage value of Equipment = $4,000,000

Add: Recovery of working capital = $300,000

Cash flow in year 20 = $6,600,000

10.The answer is

The property on which the plant will be built has bought in 1950 for $10,000

This is a sunk cost already incurred and hence not relevant